This week, I want to discuss the state of the economy. Although it can be a dull subject, I am hearing a lot about the impact inflation is having on your wallets. Some will remember the effects of inflation from the 1979 energy crisis, but for many working people and young families this is their first experience with a significant spike in inflation.

As background, inflation can be simply defined as a general increase in prices that decreases the purchasing power of money. There are two metrics most often used to determine the extent of inflation: the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE). The CPI is consumer-based and essentially determines the changes in price in relation to the cost of living by measuring the difference in out-of-pocket expenditures by urban households from month-to-month. Conversely, the PCE measures changes in the price of consumer services and goods using business and supplier data.

Since the early 1980s, inflation has usually hovered around 2% to 4%. In June 2022, the increase in CPE from June 2021 was 6.8% and the estimated CPE for 2022 is 8.6%. Needless to say, this rate is unsustainable.

So, how did we get here and where do we go from here?

The COVID pandemic placed our global economy in a precarious position. Although government mandates on the workforce varied from state-to-state, the initial economic impact was relatively uniform nation-wide: safety protocols slowed supply chains and manufacturing; many people left the workforce either temporarily or permanently; and numerous service industries saw significant decreases in demand.

The federal government responded in several ways. Some of the early programs, like the Paycheck Protection Program, provided critical loans to businesses so they could maintain their payrolls as revenues declined, essentially helping to maintain the status quo. However, even as people began to return to their jobs and many businesses began to normalize, the federal government continued to inject trillions of dollars of stimulus into the economy.

Economists have boiled down the path to high inflation into three main events. First, the pandemic shifted consumer demand away from services and towards goods, but producers were unable to keep up with demand. Anyone who was looking for an outdoor pool, camping or outdoor gear, exercise equipment, and cleaning supplies in the summer and fall of 2020 will remember. This caused prices to rise. Then, stimulus money increased consumer buying power and caused the demand for goods to rise even further, even though factory closures and supply chain shortages continued to stall producers’ ability to meet demand. And so, prices rose again. Finally, Russia’s invasion of Ukraine caused a spike in oil prices, which increased the cost of both manufacturing and shipping, and forced up the price of agricultural products and other commodities. Closer to home, costs for corn, soybeans, and wheat were already rising as drought conditions reduced the supply these and other crops. Increases in the costs of manufacturing and delivering goods, and higher than normal food prices, both from weather and Russia/Ukraine conflict, sent the CPE up even further.

You can see how easily we reached a state of high inflation. The path back to a more balanced economy is less clear, but there are a few simple things we can do.

The first thing we need to do is follow the old saying, “If you find yourself in a hole, stop digging.” Injecting more stimulus dollars into the economy now is akin to putting gasoline on a fire, especially when labor is still in short supply and supply chain, manufacturing, and transportation sectors are continuing to rebound.

To be clear, stimulus money is not the only thing that contributed to our current inflation and inflation is a natural side effect of economic expansion. As businesses grow, they hire more workers, unemployment falls and households have more money to spend, so demand for goods and services increases, which causes prices to rise. However, money typically enters the market at a slower pace than it did during the pandemic. The Federal Reserve Bank of San Francisco has estimated that government stimulus may have added 3% to the national inflation rate and we can’t afford to continue artificially introducing more money into the economy.

The second step we must take is to encourage supply and demand to come back into balance. Right now, supply is insufficient to fill the current demand which has caused prices to rise and inflation to increase. If supply can begin to meet or exceed demand, then prices will fall and inflation will decline.

The Federal Reserve responded to high inflation by quickly raising short-term interest rates with the goal of slowing the demand for goods by making it more expensive to borrow money for vehicles and homes. Typically, this would reduce inflation, slow economic growth, and move us into a recession. The Federal Reserve would then lower interest rates to stimulate the economy to grow once again.

However, this cycle is facing some unusual challenges. The greatest challenge to solving the inflation problem in the current environment is that the supply chain is still not fixed and many businesses are still hiring (at elevated salaries) to find qualified people to fill open jobs. Historically, recessions begin with job layoffs due to oversupply, but we are not seeing that at this point. Similarly, higher interest rates are impacting the affordability of housing and slowing housing demand, but the ability to access affordable housing was a challenge even when interest rates were low.

As the Federal Reserve focuses on decreasing demand by increasing interest rates, I believe we made the right move at the state-level by investing in supply. The Legislature used federal American Rescue Plan Act dollars to invest in infrastructure, housing, businesses, and services that will increase the supply of goods, services, and labor in Nebraska. In addition, we have used record state revenues to return money to the taxpayers both directly and indirectly.

Time will tell if we are indeed in a recession and whether interest rate hikes will lower inflation, but Nebraska is in an excellent fiscal position in comparison to many states. The Legislature wants to keep serving Nebraskans through responsible fiscal policy and economic programs that make a real impact on our communities. If you have ideas for 2023 legislation, please reach out to me at mjacobson@leg.ne.gov or 402-471-2729. My door is always open!