Inflation Pressure: Another Angle

One of the safest ways to identify inflation pressure in the economy is to look at how consumer spending trends in comparison to wages and salaries. It is a healthy sign of economic stability when household outlays vary closely with work-based income: the input of value into the economy is balanced against the value taken out of it.

A less accurate but more common version of the same reasoning is that supply and demand are balanced against each other.

When consumer spending exceeds work-based income, the balance is potentially a source of inflation. That pressure does not arise so long as the balance – consumption less work-based income – is covered by other value-adding activities. Those activities can be of two kinds: equity-based income or tax-funded transfers of income between private citizens. Either way, value is put in where value is taken out.

The problems with inflation begin when value taken out exceeds value put in. The private sector does not create this gap – they can’t, because the private sector cannot create value out of thin air. Government, on the other hand, can do this by means of monetary expansion: by using newly printed cash to fund expenditure, government creates a monetary inflation pressure in the economy.

When this deficit monetization is concentrated to the funding of cash-based entitlements, it creates an acute inflation threat in the economy. This type of entitlements pumps out cash right into the pockets of consumers, cash which has no reciprocity in production-based value; the monetization of deficits drives a value wedge in between supply and demand. As a result, consumer prices begin to rise.

If, at the same time, there are supply disruptions, the upward pressure on prices is exacerbated. This happened in the U.S. economy in 2020, when the same Covid-19 stimulus bills that spent newly printed cash on entitlements to households also incentivized unemployment over workforce participation (primarily by means of unemployment bonus checks).

As the statistical picture of 2020 becomes complete, we see more and more signs of this inflation pressure. Figure 2 below reports an inflation-inducing imbalance between work-based income and consumer spending, but before we examine it in detail we need to take a look at a sustainable balance between these two variables. Figure 1 provides the growth rates in wages and salaries, and private consumption. The numbers are reported monthly at annual rates:

Figure 1

Source of raw data: Bureau of Economic Analysis

As the economy went into a recession, unemployment soared and work-based income declined. However, consumer spending declined more; for the duration of the recession the balance between consumption and work-based income was deflationary in nature.

That was not the case in 2020:

Figure 2

Source of raw data: Bureau of Economic Analysis

Consumer spending stayed ahead of work-based income, shrinking at lower paces and then growing when work-based income was still in decline year over year. The balance has to be made up by either equity-based income or by monetized entitlements. Since it is mathematically impossible for the difference to be explained by soaring equity income (there just isn’t enough) we are looking at an entitlement-based gap between consumption and work-based income.

This gap is yet another illustration of the inflationary pressure that is caused by excessive money printing for the purposes of funding entitlements. This week’s Economic Newsletter will go further in depth into what this inflation pressure looks like. Subscribe today, either monthly for only $2.99/month, or with a one-year subscription. For the second option, send a check for $36 and your email address to:

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