Rising retail prices is called inflation. Higher prices without higher incomes reduce people’s ability to buy. Since the 1990s, inflation has run at a very modest pace.

But in 2021 a spike in inflation occurred. Why?

It’s basic economics: demand is outrunning supply!

First, COVID has disrupted the production and distribution of goods. Some producers closed their doors, some had to restart production in the midst of a labor shortage. Due to globally connected economies, goods come from everywhere, and the virus affected many economies’ capacity to produce given lock downs, social distancing, and hospitalizations.

Second, consumers switched to buying more goods relative to services because of the existing virus. This demand change forced manufacturers to move resources to more goods production, a costly undertaking.

Third, government and Federal Reserve stimulus is at play. Public measures employed to assist people during the pandemic have fueled more spending. Some industries cannot meet this demand in the short term, so prices rise.

But there is a non-COVID element to this: Beginning in the 1980s, but especially since the 1990s, American business has concentrated. Concentration causes a reduction in business competition.     Pushing prices through the entire supply chain out to retail prices protects the profits and purchasing power of companies.  Declines in purchasing power occur for everyone whose income rises less than the price hikes.  While this is not necessarily inflationary, concentration does give firms the means to pass through any imposed cost increases to retail prices.

Policy Suggestion: Support policies to restrict business mergers and buyouts.

Modest levels of economic inequality go without condemnation. People’s incomes can vary from differences in effort, education, innovation, and career choice.

Inequality is problematic when the range of high to low income is vast or when income is concentrated in a small percentage of people at the top of the income ladder.

Vastly different incomes are largely associated with people who control and / or own large commercial enterprises. Large property possession rewards people for their labor, but also for their organizational and risk-taking efforts connected to the control or ownership of property.

Whether one finds the role that property plays in creating inequality justifiable, there are three basic reasons to be concerned about very high inequality:

1. Economic Activity: When a large percentage of a nation’s income is concentrated at the high end, those people place much of that money into savings accounts and pensions, not into the purchase of goods and services. High inequality therefore deters employment growth.

2. Speculation: High inequality means there is much cash in the hands of a few people. An important outlet for this money is speculative financial markets. This use of cash can drive up asset prices to unsustainable levels, setting up the stock and other markets for a crash.

3. Power: The people advantaged by high inequality have a heighten means to affect legislation, to set the parameters of policy debate, and to impact public thinking. To some extent, a small minority can rule the majority.

We know how to moderate inequality because the country did so in the middle 20th century: have high income people pay higher tax rates than low income people, finance poverty programs, implement social insurance, enlarge public funding of education, expand voting rights, and encourage collective bargaining.

Why does the federal government spend more money than it takes in?

Government spending and taxing is called fiscal policy. Fiscal policy is a means by which government affects economic activity.

Here is how to think about the effect that deficit spending has on the economy.

Assume you and I are the economy. I spend all of my money on you and you spend all of your money on me. If we do this, we are both running balanced budgets. And note that my spending is your income, and your spending is my income.

Now assume I borrow money so I can increase my spending to buy more goods from you.  If I do this, I run a deficit budget.  But my “excess” spending or deficit must be equal to your additional income. This means you have a surplus budget.

My deficit = your surplus!

With that additional income you are likely to spend more, which would increase my income.

Economists know that when this occurs throughout our actual economy, deficit spenders create surplus incomes for others, who in turn spend more money.  As spending rises in the real economy, more goods are produced and more people are employed.

Finally, think of the economy in terms of two sectors, the private sector and the public sector. When the private sector experiences recession or unemployment, the public sector deficit spends in order to create surplus budgets for households and firms.

What the private sector would not want is for the public sector to run surpluses because that would force the private sector into deficits.

In sum, deficit spending by some people raises other people’s incomes, and then these people encourage more economic activity by increasing their own spending. Fiscal policy is therefore a tool directed at reviving an economy from recession or stagnation.  A great example is the government’s current deficit budget policy to mitigate the economic effects of COVID-19.

Now you know the essence of the economic role of government.