Ahmed Rahman Explains Inflation

In this episode of Lehigh University’s College of Business ilLUminate podcast, we are speaking with Ahmed Rahman about what's driving inflation in the United States and around the world, and who benefits and who loses when inflation is high.

Rahman is an associate professor of economics who holds the Charlotte W. & Robert L. Brown III '78 Summer Research Fellowship. He also is a research fellow at the Institute of Labor Economics. His research areas include economic growth, economic history, immigration, and the economics of education.

He spoke with Jack Croft, host of the ilLUminate podcast. Listen to the podcast here and subscribe and download Lehigh Business on Apple Podcasts or wherever you get your podcasts.

Below is an edited excerpt from that conversation. Read the complete podcast transcript. 

Croft: Compared to what’s going on in other parts of the world, how has the U.S. fared in handling inflation?

Rahman: I would say it's mixed. It's not great. We can look at the fiscal side, and were they responsible? The fiscal policy is never really directly responsible because they're not mandated to consider inflation. But I would have to say that the fiscal side made things worse. That seems clear.

Take the Inflation Reduction Act, for example. There’s some great things in this bill, but the title seems rather Orwellian to me, because it's a bill that's focused on green stimulus. However one might feel about the environmental benefits of the bill—and look, there's a lot of things in there that I think moderates to progressives can really get excited about—but stimulus typically stokes inflation. It doesn't tamp it down. Now, admittedly, there are disinflationary effects that probably will come from this bill, but those are going to take years to manifest themselves. If anything, this bill is going to go in the other direction.

On top of that, many governors around the country [are] trying to outdo one another in providing tax breaks to their constituents. Ostensibly, this is to help people afford basic purchases in the wake of these explosive price increases. But in reality, these sorts of measures often just help fuel further price increases by raising demand further. And that can make things potentially even worse. To me, these governors are kind of killing us with their kindness.

[These are] just some examples of how fiscal policies in this country have potentially made things worse. It also highlights why inflation fighting in the first place should be left to those who are kind of immunized from the concerns of the political cycle—should be left to those who aren't always running for office. And that's the central bank. That's the Federal Reserve. That's the group that really is responsible.

Croft: I want to move into the area of who's benefiting, who's losing as a result of inflation. And I think exhibit A for most people are the oil and gas producers, who have made record profits this year and their stock prices have far outperformed the rest of the S&P 500. Some are calling it price-gouging. Is that what it is? Or is there something more complex than that going on here?

Rahman: Maybe you won't be that surprised if I say, "Yeah, it's a little more complex." [laughter] But it's not to say that the argument of price-gouging is entirely without merit. I mean, inevitably, you're going to have some firms that are going to benefit a lot. We've actually quite literally heard about the evidence in these earning calls, where CEOs are saying, "Hey, this inflation is actually helping us big time in terms of our bottom line."

And in some ways, it's inevitable when you sell a product whose price is rising and whose price demand is fairly inelastic, meaning that consumers don't tend to substitute away from the product when the price goes up. And hello, that's energy in a major way, as well as some other products that simply people won't be able to move away from even if prices rise. But at the same time, there are some structural things that creates a situation where it looks like these firms are benefiting when in fact it's not much they can do in terms of living with those price increases. Supply response is one thing. Energy supply responses tend to be inherently sluggish. Just drilling-- I mean, it just takes a long time to set up the infrastructure to do it.

On top of that, demand for oil and gas is a lot bigger in Europe than America, and that's fostering a lot of exports to Europe. That's simply the product goes where the demand is, but it's exacerbating our price increases here at home.

Croft: Besides the energy industry, who else or what other sectors benefit when inflation rates soar the way they have in the past year?

Rahman: One group that surprisingly can benefit are debtors. The size and extent of this inflation has caught nearly everyone off guard the last couple of years. So people who borrowed money before 2022 are now finding their debt burdens a bit lighter. Their interest rates that they had locked in are going to often be much smaller than the rate at which current inflation is lowering the value of these interest payments. Because to most of us, inflation was a surprise, it turns out lenders set their rates too low. As a consequence, many lenders now look like they're paying their borrowers to take their money, which, whoopsie, that's not something they intended, but that's simply one of the consequences of unanticipated inflation. So those with fixed mortgages or student loans are somewhat shielded from the more problematic aspects of inflation due to their lower debt burdens. There's a silver lining. If you owe money, you don't owe quite as much money.

And let's face it. There's going to be more wealthy individuals in the economy who will be able to shield themselves from inflation far better. So while they're not winners, they're sort of, at least relatively speaking, better off as opposed to those who cannot shift their burdens—those who, for example, spend most of their money on food or housing, where inflation is going like gangbusters. And at the same time, food and housing is something that we all need. But as a relative share of our income, those who're poor tend to spend the vast majority of their income on those things. So they're seeing their real incomes plummet a lot because of what they spend on.

Wealthier people can shield themselves simply because as a fraction of what they make, they don't spend that much on those things where inflation is going up a lot. So that's one of the more deleterious aspects of inflation, is that it creates this sort of winner and loser scenario in the economy. It's bad from an efficiency perspective, but it's also bad from an equity perspective as well.

Croft: What kind of grade would you give the Federal Reserve for how it has handled either restraining or managing inflation? And are there steps they could have taken that they did not?

Rahman: I would say C minus, maybe, which is not terrible, but man, they could have done a lot better. For 30 years, central banks focused on so-called inflation targeting. That is, they're shooting for a specific rate of inflation, the rate of price increases, and almost implicitly make a promise that that's the rate that's going to be, or at least they're going to do everything in their power to get that rate to that specific point. And I would have to say the Fed, generally having the tools to stop inflation, kind of failed to use them, at least in time. So now we have the worst overheated economy, which is our economy as a big rich economy, in those past 30 years. What accounts for that? As I said, the fiscal side definitely was making things a lot more heated, and the Fed failed to kind of offset that.

One key thing to remember is, like our parents had taught us, breaking promises always has consequences. Maybe not immediately, but over time. The Federal Reserve—which is our central bank, the most important central bank on the planet—promised us a stable and modest inflation of about 2%. And for a long time, they have been under-delivering. And now they are wildly over-delivering.

This hurts lots of Americans, as we mentioned. It also hurts other long-term bond holders, foreign central banks, and governments who owe $4 trillion, for example, worth of treasury bonds. What might happen is they might put an inflation risk premium on America's cost of borrowing, and that would be bad for all of us. And then the other thing is, if even America—the paragon of financial probity—breaks its inflation promise during tough times, I think there's worries around the world that lots of governments will do the same. So I think we have to acknowledge the fact that the U.S. continues to lead the world economy. When the United States breaks its pledges, there are ripple effects around the world that come back to us in a negative way.