Inflation Explained: California and the U.S. Battle Rising Prices. When and How Will It End?

On Nov. 9, 2021, California Gov. Gavin Newsom appeared in Monterey, at the California Economic Summit, where he delivered a relentlessly sunny statement on the state’s economic vigor as it pulled out of the pandemic-sparked recession that had gripped the country since March of the previous year.

Newsom declared that California has “no peers, and continues to have no peers,” and that the state is “world-beating in terms of our economic growth,” adding that “we are dominating in every category.”

But not everyone agrees. In fact, according to a survey by the Public Policy Institute of California released shortly before Newsom’s upbeat speech, most Californians are not in tune with the governor’s message of positivity, with 52 percent saying that they expected “bad times” economically over the next 12 months, and 63 percent expecting that children today will be worse off in the future. More than three of every four Californians in the PPIC survey, 79 percent, said that the availability of well-paying jobs was at least “somewhat” of a problem—and 22 percent, more than one of five called it a “big problem.”

As 2021 moved toward its conclusion, however, another economic worry surfaced, and one that if political pundits were to be believed, threatened electoral prospects for all incumbent officeholders in the state, including Newsom—inflation.

No Escape from Inflation for California

Nationwide, consumer prices rose 6.2 percent in October 2021, compared to the previous year, according to figures released Nov. 10 by the federal Bureau of Labor Statistics (BLS). That was the largest jump in prices in more than 30 years, since the 12-month period that ended in November 1990.  

Inflation has not missed California. In Southern California, prices across the board hit 13-year highs in August, and in November consumer prices in the Los Angeles area were 5.4 percent higher than than the previous year, according to BLS statistics. In the San Francisco-Oakland-Hayward region the BLS tracked energy prices, a major driver of inflation, and found that consumers paid an average of $4.67 for a gallon of gasoline in October, up from $3.23 a year earlier.

Electricity prices in the region were also on the rise at 25.8 cents per kilowatt hour in October 2021 compared to 23.6 cents a year earlier. Overall prices were up 3.8 percent from one year earlier in the Bay Area. According to the AAA survey of gas prices nationwide, California reigns as the United States’ most expensive gas market, with prices averaging $4.62 statewide in early November.

Unemployment nationwide is down, worker wages are up, and the stock market is riding high, jumping by 39 percent since Pres. Joe Biden won the 2020 election. And yet, according to an October Gallup poll, 68 percent of Americans believe the economy is getting worse.

Inflation is not the sole reason for the country’s dark economic mood, but according to Gallup it is one of the major factors “outweighing the positive aspects of the economy.”

How bad is it? And will it get worse, or will the recent rise in prices reverse as the county makes better progress pulling out of the COVID-19 pandemic? Many economists, including U.S. Treasury Secretary Janet Yellen, believe the pandemic has been the driving force behind inflation in 2021.

What Is ‘Inflation,’ Anyway?

The average person perceives inflation as prices going up, which of course is the most obvious manifestation of the problem. But what actually inflates in a period of inflation is the supply of money circulating through the economy. At the heart of inflation is a decrease in the value—that is, the purchasing power—of money. As the value of money goes down, prices go up because it takes more money to buy the same amount of stuff.

Economists classify inflation into three main types. “Cost-push” inflation happens when the supply of goods or services drops, but not the demand. “Demand-pull” inflation has it the other way around—the supply of stuff stays the same, but demand goes up.

Then there’s what economists call “built-in” inflation, which is inflation seen as a self-fulfilling prophecy. When prices go up—or even when people merely expect prices to go up—workers demand increased wages to keep up with the cost of living. Higher wages increase the cost of producing goods and services, so companies raise their prices. And so on, as inflation continues to spiral upward.

Inflation is generally measured by the Consumer Price Index, an average calculated by the federal government of a wide range of goods and services, including essentials such as food and energy as well a variety of other products, from clothing and medicine to college tuition, television sets, cars, insurance and dozens of other things.

But economists, when they try to foresee future inflationary trends, will often use a measure called “core inflation,” which is basically the same as the Consumer Price Index, except with food and energy prices left out. The prices of those commodities, which are widely traded on the open commodities markets, are so volatile that they can throw off the ability to predict overall inflation.

The ‘Great Inflation’ of the 1970s

This is far from the first time that prices have spiked, putting pressure on the pocketbooks of ordinary Americans. Nor is it the worst. In fact, compared to the “Great Inflation” of the 1970s, the current period of rising prices is mild. The ’70s saw double-digit inflation some years, though the average inflation rate for the entire decade was 6.8 percent. Nonetheless, according to Princeton University economist and former vice-chair of the Federal Reserve Alan Blinder, that was triple the rate of the previous two decades and double the country’s long-term historical average.

In 1964, inflation ticked up at a barely perceptible 1 percent, a rate it had held for six straight years. In the mid 1960s prices started to creep up. By 1972, inflation reached 3.4 percent. Then it suddenly rocketed skyward. The rate in 1974 was a double-digit 12.2 percent. It then sank to 4.8 percent in 1976—only to blast upward to reach a smothering 13.3 percent in 1979 and 14.8 percent in the first half of 1980.

The two surges were caused by “shocks” to the economy. As Blinder recounted in his 1982 paper for the National Bureau of Economic Research, a rapid increase in the price of food caused by poor weather in the U.S. and abroad coupled with the sudden hike in the cost of Middle Eastern oil to jolt the economy and send prices through the proverbial roof. The oil price hike was caused by oil-producing countries tightening the supply and, as a result, quadrupling prices. This strangling of the oil supply occurred after Israel repelled an attack by Arab countries in the Yom Kippur War of 1973.

How Presidents Fought Inflation in the ’70s

The third shock was caused by the president of the United States himself. In August of 1971, President Richard M. Nixon took a drastic measure never before (or since) employed during peacetime. He ordered a freeze on all price and wage increases. The freeze was intended to last for 90 days but, with several modifications, didn’t fully expire until April of 1974. When it did, prices exploded.

Nixon’s successor, Gerald Ford—who took over in August 1974, when Nixon resigned over the Watergate scandal—took a much softer approach. In his “Whip Inflation Now” program, he asked Americans to grow more food and not waste as much, to drive less and turn down the thermostats in their homes. Unsurprisingly, Ford’s “WIN” program didn’t do much.

More food and energy shocks struck in 1978 and 1979. In August of 1979, Pres. Jimmy Carter appointed Paul Volcker, an economist who headed the Federal Reserve Bank of New York, to chair the Federal Reserve Board of Governors. Volcker quickly raised the Fed’s interest rate to 20 percent, tightening the money supply and setting off back-to-back recessions that cost 4 million people their jobs.

But Volcker’s iron-fisted policies finally put an end to “double digit” inflation, bringing the annual rate to about three percent by 1983.

What’s Causing Inflation in 2021?

The causes of 2021’s problematic but, compared to the 1970s, somewhat minor spike in inflation remain in dispute. Conservative economists contend that Biden’s policies have caused inflation by flooding the economy with cash. Specifically they cite the $1.9 trillion “American Rescue Plan” COVID relief act which the president signed in March, and the $1.2 trillion bipartisan infrastructure bill Biden signed on Nov. 15, 2021.

Paul Krugman, the Nobel Prize-winning economist and New York Times columnist, disputed the conservatives’ claim that pumping money into the economy is the cause of inflation in 2021. Demand for goods and services has not risen significantly, Krugman wrote, noting that “real domestic final spending”—the total of all consumer and government spending—was up just 3.8 percent over the last two years, a number consistent with “normal potential growth.”

The more likely problem, Krugman writes, is a bottleneck in the supply chain coupled with the unusual phenomenon of consumers buying more goods, as opposed to more services, a development “which I don't think anyone saw coming.”

Pandemic Drives Inflation

And what caused those two different but linked phenomena? They’re both results of the pandemic. Business shutdowns, “lockdowns” in which people were asked to cut way back on their daily travels and interactions with their fellow humans, and other pandemic-related health restrictions appear to have created a demand for more stuff—groceries, home entertainment devices, furniture and so on—while also reducing the demand for experiences provided by the service sector.

In the fourth quarter of 2020 alone, spending on all durable goods rose by almost 12 percent compared to the same period in 2019. But spending on services—recreation, health care, restaurants, etc.—dropped by 6.8 percent.

The supply chain that gets products from manufacturers located all over the world to wholesalers and retailers, who then sell them to consumers, was overwhelmed. The increased demand for goods also led to a shortage of home delivery truck drivers, while lockdowns around the world caused cutbacks in shipping. That also led to a shortage of shipping containers, as fewer ships meant more containers that sat on docks without being picked up and reused.

After the Biden administration announced plans to keep the ports of Los Angeles and Long Beach—which jointly account for 40 percent of all shipping containers entering the U.S.—open on a 24/7 basis, those two ports said they would fine shippers $100 per day for each container left to sit on the docks. Within a month, the ports saw the number of abandoned containers drop by 33 percent.

But according to Treasury Secretary Yellen, there is only one sure way to unblock the supply chain and bring inflation back to its previous levels—end the pandemic once and for all.

“The pandemic has been calling the shots for the economy and for inflation,” Yellen said in a November interview with CBS News. “And if we want to get inflation down, I think continuing to make progress against the pandemic is the most important thing we can do.”