Inflation and the Economic Consequences of COVID

By Drew Lemon ’24

Drew Lemon ’24

Over the past several months, American families have watched the prices of everyday goods and services ascend to new heights as inflation has reached never-before-seen levels. Everyday goods and services such as food, clothing, home supplies and air transportation have become impossible to purchase for many families across the United States.

The fundamental cause driving the current inflation in the U.S. all stems from one impacting event: the COVID-19 pandemic. As state and local governments implemented restrictions and quarantines, Americans strongly restricted their daily economic behavior and spending activities. As governments eased restrictions as COVID and its subsequent variants began to fade, Americans were thankful to get their lives back. But the government policy responses to the pandemic itself created a shift in Americans’ spending behavior, fundamentally changing economic conditions and leading to the inflation that the U.S. faces today.

The COVID-19 pandemic substantially reduced U.S. consumer spending. During the second quarter of 2020—at the beginning of the pandemic—American consumer spending was down 9.8 percent compared to the previous year, which was the single largest quarterly contraction in over 70 years. Moreover, the pandemic continued to curtail spending through 2020 and into 2021, but businesses began to adapt. As businesses changed to fit the decreased consumer demand, over 40 million people were laid off, decreasing U.S. gross domestic product and the production of goods and services across many U.S. firms. 

Congress’s response, sending stimulus money to help Americans, pumped an overbearing amount of cash into an already stagnant economy without any thoughtful coordination or planning. 

During the pandemic, and both the Trump and Biden administrations, Congress passed the CARES ACT, the Heroes Act and the American Rescue Plan, which spent a total of over $5 trillion to help individuals, families, businesses and the healthcare system, and to provide aid to state and local governments. While it was right for the government to assist Americans in the form of cash stipends and tax credits, its effects completely changed the dynamics of the American market economy. 

Once pandemic restrictions ended, Americans went back to spending. People were traveling to work and school, going out to eat, shopping and traveling. However, businesses were ill-equipped to keep up with the eagerness of Americans to spend once restrictions ended, as firms had low employment and low levels of production. 

This resulted in rising flight costs, as the return of full flights indicated that passengers wanted to take to the skies, but airlines simply did not have adequate crew capacity to operate the planes, so prices were raised. Similarly, this same behavior can be seen in the car market. Car makers had a limited supply of cars due to COVID supply shortages, but consumer demand and willingness to spend on vehicles were very high, so car companies raised prices. This inflationary behavior can be seen with the used car market having its highest prices in history. 

Consequently, the relationship between consumer spending and firm production has been altered. A major increase in consumer demand coupled with insufficient firm supply has generated inflation.

The issue with Congress’s response to the pandemic was not the stimulus money itself, but a lack of thorough foresight and planning for how quickly American demand would rebound after pandemic restrictions ended.

Congress should have considered more carefully the high levels of spending that would occur as Americans were given more cash, while further giving businesses employment enhancements and tax breaks to help with boosting the firm supply and production to meet consumer demand. 

Additionally, the Federal Reserve bank’s decision to implement interest rate hikes was too late. The Fed should have decided to increase interest rates earlier, when the initial signs of inflation were beginning to show in July 2021, rather than deeming inflation to be temporary. In June 2022, the Fed implemented its largest rate hike since 1994, which could run the risk of generating a recession if the hike is too much of an overcorrection for inflation. 

Policy-makers and the Fed need to be critical in the future of how they observe and adapt to changing levels of inflation. Both institutions need to understand that appropriate levels of demand need to be supported with job growth and full business operation to generate adequate levels of supply. Only this can bring down long-run prices for Americans.