Inflation is there. And now?
The central fact of the US economy in mid-2021 is that the demand for all kinds of goods and services has increased. But supplies are slowly coming back, with the economy acting like a squeaky machine that’s been turned off for a year and some parts are rusting.
The result, as highlighted in new government data this week, is shortages and price inflation in many sectors of the economy. This puts the Biden administration and the Federal Reserve in a traffic jam that is only partly on their own initiative.
Rising prices and the other problems that result from an economy restarting on its own are frustrating, but should be temporary. Yet the longer the price spikes last and the more parts of the economy they encompass, the greater the chance that the US price and inflation psychology will evolve to become self-sufficient.
Over the past decades, companies have resisted price hikes or rising wages because they felt it would cost them too much business. This has curbed inflation throughout the economy. The question is whether current circumstances are changing in a way that could change this.
“Now the genie is out of the bottle,” said Kristin Forbes, an economist at MIT and a former US Treasury and Bank of England official. “If everyone raises the prices, it becomes a lot easier for you to do that too.”
To understand the bewildering mix of forces at play, think about what’s going on at the nearest used car fleet.
The price of used cars and trucks rose 10% in April, according to the latest federal data, a major factor that pushed the Consumer Price Index to its strongest year-over-year jump. another in 13 years. People in the auto industry say it has not one cause, but several – each with different implications for the economy and for politics.
Some relate to the microeconomic decisions made by businesses and consumers several months ago and which continue to permeate the automotive market.
Car rental companies reduced their fleets during the pandemic-induced travel collapse and are now struggling to replenish their stocks – and therefore do not sell the used cars they were continually unloading in a normal market. New car sales fell last year during the pandemic, which has reduced the number of takeovers in the used car market, and new car sales are now being held back by a shortage of microchips.
There is little government policy can do to solve these problems unless it involves a time machine. But government policies are history.
The combined $ 2,000 per person stimulus checks that most Americans received in the first few months of the year represent a healthy down payment for many families. Generous unemployment benefits help contain the number of overdue auto loans and, in turn, the supply of repossessed cars on the market. The Fed’s low interest rate policies made financing cheap.
But imagine that in response to the problem, the Fed raised interest rates or Congress raised taxes to claw back the stimulus payments.
These actions alone wouldn’t create more microchips or allow car rental companies to reverse decisions of a year ago. Higher interest rates or taxes could even make matters worse if the actions cause suppliers not to invest in new capacity for fear that demand will decline in the future.
The used car market could start to stabilize at the end of this year, but the issues are unlikely to be fully resolved until 2022, said Jessica Caldwell, auto industry analyst at Edmunds.
“The only winners here are the people who have a vehicle that they want to get rid of,” she said. “If you have a car for sale that you don’t need, that’s crazy what you can get for it.”
All the time, the prices of some things go up and the prices of others go down, for all kinds of idiosyncratic reasons. Policymakers generally try not to react to these movements; they are essential to the functioning of markets. If there is a shortage of limes, their prices go up and people use more lemons.
What’s unusual right now is that the prices of so many things are going up at once, albeit for different reasons. Some, like air fares, simply revert to pre-pandemic levels, which appears in the inflation data as a price increase. Others, such as timber prices, reflect strong demand and a short-term fixed supply.
And still others, like soaring gasoline prices on the East Coast after a cyberattack shut down a major pipeline, are truly random events that tell us next to nothing about undersupply and demand. underlying or future inflation.
Some other sectors appear to be on the verge of price increases. Restaurants, for example, complain of severe labor shortages that are forcing them to cut service or dramatically increase wages for line cooks and dishwashers. If they try to reflect these higher costs in their prices, the price of food out of their homes will start to rise faster than last year’s (already pretty high) figure of 3.8 percent.
Professional inflation watchers have been watching closely for signs that these forces may trigger some form of price dynamics thinking unseen since the early 1980s, when prices rose in part because everyone was there. was waiting.
The Fed is betting this won’t happen – that even if there are several months of price spikes, it will be a one-time adjustment at worst, and potentially something that reverses when old spending patterns come back and workers will return to their jobs.
“If past experience is any guide, production will increase to meet the level of demand for goods soon,” Fed Governor Lael Brainard said. in a speech this week. “It is unlikely that a limited period of price increases linked to the pandemic will permanently change the dynamics of inflation.”
For now, moves in major financial markets are mostly aligned with the Fed’s point of view.
And in the bond market, even after a surge in long-term interest rates after Wednesday’s high inflation, most signs point to future inflation in line with the 2% the Fed is targeting.
Nonetheless, the level of future inflation implied by these bond prices has risen significantly in recent weeks, which means further measures should heighten fears that inflation problems may not be so transient after all. And the trend could change abruptly if more and more evidence starts to come in that the inflation outlook is no longer anchored.
“We’re obviously not on the path to a very high and persistent inflation result,” said Brian Sack, director of global economics at DE Shaw hedge fund and a former senior Federal Reserve official. “But we’re at an inflection point, as the rise in inflation expectations to date has been a political success, but a rise from here could become a political issue.”
The Fed may believe that the evidence emerging in various corners of the economy is a one-time event that will fade from memory for too long. The Biden administration is betting its agenda on the same idea.
At the end of the day, what matters more than anything the bond market does is how ordinary Americans who make day-to-day economic decisions – demanding increases or not, paying more for a car or not – view them. things. Can they wait for the complex cogs of the US economy to fully kick in?