Decades-high inflation taking big bite out of Minnesota budget surplus

By: - January 3, 2022 6:00 am

American consumers are seeing steep rises in prices of many every day items, including energy. A propane tank in Pine City, Minn. Photo by Max Nesterak/Minnesota Reformer.

The November Minnesota state budget and economic forecast painted a rosy picture of the state’s finances: lawmakers have an expected $7.7 billion budget surplus, the largest surplus the state has ever forecasted. But some of the state’s top economists warn that surplus figure is incomplete because of a 2002 law change that prohibits budget forecasters from factoring inflation into government spending estimates. 

Even in the forecast report was a warning from the Minnesota Council of Economic Advisers, an outside group of experts tasked with advising state budget officials, that inflation would reduce the surplus by an estimated $1.2 billion. 

“Minnesota’s current practice of excluding projected changes in the prices of goods and services from a majority of the spending estimate is fundamentally misleading,” they wrote. “It is inconsistent with both sound business practices and CBO (Congressional Budget Office) methods.”

University of Minnesota marketing professor Mark E. Bergen, an expert in pricing, spoke to the Reformer about why inflation is suddenly so high, how it will affect government spending and whether a president can be held responsible for rising inflation. This interview is edited and condensed for clarity.

Can you put into perspective or into context the current rate of inflation and why it’s so concerning?

The thing about inflation is we just haven’t seen this level for nearly 40 years. It’s been a generation since we’ve seen numbers this high. A third of people haven’t even experienced it before. Even for those of us like myself who are old enough to have experienced it, we’ve long since forgotten. We’ve lived in a world of very stable pricing for a very long time. There’s good reason to believe that it could persist for some time. It also isn’t stable so it can go up for a while and then go back down and then go up again. 

What categories of goods are seeing the biggest increases and what’s causing it?

You’ve seen it in food, energy, autos, both new and used; also housing and rent. We did something in our class where we surveyed leaders across a variety of industries, and it’s really quite widespread. Every industry mentioned that their costs had increased significantly at levels they hadn’t anticipated, which meant they were raising prices more often and by higher amounts than they ever had in the past. 

Labor costs are going up, especially in industries that have a lot of labor in them like restaurants and other kinds of places that are labor-intensive. You’ve had supply constraints and shipping constraints. Industries that have computer chips in them have had to raise prices.  Raw materials prices have gone up. I saw one number for steel that went up 150%, so (that affects) anything that’s made of steel: housing,  snow blowers and lawn mowers. 

Anywhere where the supply goes down, but the demand stays high, then you’re going to see prices reacting to that.

It’s a perfect storm of cost going up, supply constraints and demand as the economy opened up after the pandemic.  The government also has been very active in spending to try to help keep the economy going. That’s led to large federal budget deficits and even more money chasing even smaller numbers of goods and services. 

One of the things that the Minnesota state government does is borrow money to pay for public infrastructure projects. Given the rising costs of raw materials, will it cost more to build now compared with before when inflation was more stable? 

Absolutely. Inflation will raise the cost of the government doing business. You can think of that in the roads with the equipment and in the raw materials and the labor. I would anticipate that you’ll see the price for almost everything that the government is spending for will go up. Government won’t be immune to inflation. 

The Minnesota Council of Economic Advisors recently noted that the lack of accounting for inflation in spending estimates really presents a problem because it’s fundamentally misleading, noting it paints a rosier picture of a surplus than it really is because that surplus will be eaten up by inflationary pressures. That change in how the forecast estimates government spending was made in 2002. What do you make of it?

When that was written, that would have been a reasonable position given the levels of inflation we were seeing. I think the reason they noted that so strongly in the forecast is because up until now, inflation has been largely stable. They’re saying now that we’re seeing a big problem with inflation, now it really is misleading. You’d want government budget forecasters to factor it in. No one knows how long it will stay. It may stay at levels higher than you’re seeing for some time.

The Federal Open Markets Committee has revised some of its recent public statements on inflation. Initially, the Fed said inflation would be transitory, or brief, but have since hedged by saying inflation is “expected to be transitory” in a November statement. It doesn’t seem like they expected inflation would go on for as long as it has now. What does that tell you?

What’s happened is inflation is at a higher level and is more persistent than was anticipated. I would anticipate it for several months, and, again, these things move around. It is a volatile thing, so it is very hard to predict and to estimate.

They’ve taken people by surprise. They knew there were pressures but didn’t think it wouldn’t rise this fast. The Federal Reserve Bank is going to have those interest rate increases, which will affect the cost of borrowing, so that’ll also affect the state budget. So now you’ve got action by the Fed that hopefully will help rein it in. It’s a good thing that they’re being attentive to it and putting steps in place to help address it. 

With inflation as high as it is and heading into an election next year, Republicans are trying to blame inflation on President Joe Biden’s policies. Realistically, regardless of who is in the White House, how much can a president be blamed for higher inflation?

There’s multiple sources of inflation. A lot of them are called microfoundational: supply constraints, cost increases in commodities, labor cost increases. These are all things that are going to be beyond macro or government policy, just simply things happening in our economy outside the control from a political point of view. 

From a macroeconomic point of view, running large deficits and pumping a lot of money into the economy will create inflationary pressures. 

It certainly makes sense in light of covid and the economic contractions and issues that faced our government, as all governments, that have been spending freely and running large deficits – and for good reason. 

I don’t use the word blame, but to that point, it is true that government policy, the spending and deficit spending, adds fuel to the inflationary fire. Politically, I don’t see it being unique to either party or any particular president.

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