|M1, Billions of Dollars at end of Period||Average Monthly Change in M1, Billions of Dollars|
June 1998 - June 2008
June 2008 - April 2020
April 2020 - Feb 2022
Over a ten-year period ending in June 2008, the Federal Reserve increased M1 by an average of $2.7 billion a month. At that point in time, the Fed began reacting to the housing market meltdown, and went on a huge money printing expedition. The money supply was increased almost 9 times faster per month from June 2008 to April 2020 than it did during the previous ten-year period. However, since April 2020 (and through February 2020, the last date for which data has been released), the money supply has been increasing at what can only be described as an outlandish rate of $753.6 billion a month. That is a ludicrous 275 times faster than it was growing in the ten-year period before the Fed reacted to the housing meltdown in June 2008. In fact, the average monthly change in M1 since April 2020 is equal to more than half the total money supply in June 2008!
All that money sloshing around in the economy had to go somewhere, and among the places it went was higher prices. One person’s higher prices, of course, are another person’s increased costs. Those costs then got passed on to their customers, and inflation first began, and then began to feed on itself.
So now what? The Fed has announced they are going to do something about inflation. This may result in the soft-landing they intend, and there are two theories that suggest the Fed might accomplish just that. The first theory is that the Fed, after 14 years of giving the appearance they it behaves no more rationally than a drunken monkey, actually knows what it is doing. The second theory can be rephrased as the proverbial “even a blind squirrel occasionally finds a nut.”
Failing either of these two theories proving themselves out, what we face going forward is some combination of the Fed undercompensating, overcompensating, or a delicate dance in which the Fed sometimes goes too far, and sometimes not far enough. Either way, pain is likely, though what sort of pain, and its timing, is currently anyone’s guess.
So, if you are in charge of pricing products, what do you do now? The reality is there is a bit of guesswork involved. The first thing to do, of course, is to keep a closer watch on the available data. Incorporating a measure of the CPI, or pf the money supply for that matter, in one’s models is important, but that data is released with a lag. Depending on one’s business, market data such as commodity prices can be helpful.
Outside of modeling, there are a number of practical steps to take. Effective communication of the reason for price increases, should they be needed, goes a long way with many customers. And some customers tolerate scaling back of value-added services, such as free shipping, better than they tolerate price increases. However, this is likely to become increasing less true as customers internalize the fact that inflation is happening and ongoing.
But it is perhaps more important for companies to find ways to increase their pricing flexibility. A company that can change prices quickly and regularly can guess wrong, and then adjust as needed. It can keep prices incrementally as needed to keep up with inflation. But a company constrained to infrequent price changes does not have that luxury. It needs to set a price, and stick to it for a while, during a period of time in which the inflation is ensuring the right price is continuously changing. That means at best, it will be pricing well above what the market will bear for a while, followed by period in which it prices too low.
One pricing dictum remains true, though, even in an inflationary environment: it is easy to give a price discount but usually impossible to charge a price greater than the list price. Coupons, promotions, and other ways of passing along price cuts remain popular among customers even in inflationary environments. This means pricing too high is easier to fix than pricing too low. It also means inflation can continue feeding on itself, at least for a while.