After a decades-long hiatus, inflation is back in the news. So far, the figures this year are startling, and as anyone who remembers the great inflation of the 1970s and 1980s knows, inflation, once it gains momentum, can devastate financial markets, distort economic decisionmaking, and severely limit growth prospects. In the face of such concerns, Washington has shown little more than a kind of insouciance. Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen have told Congress not to worry and assured all and sundry that the inflationary pressure is “transitory.” More recently, President Joe Biden has likewise waved away concerns. Though there is considerable evidence that today’s inflation is a delayed response to years of excessive monetary ease, the nation should hope that Washington’s establishment is correct and it will abate soon. The alternative would be painful for citizens, investors and politicians.
Washington’s easy assurances aside, the data available can only be described as troubling. The Labor Department’s consumer price index (CPI) has risen at a 7.3 percent annual rate so far this year, up from 0.2 percent in 2020 and an average yearly rate of 1.5 percent for the prior five years, 2015–2019. Producer prices have risen at well over a 10 percent annual rate so far this year, compared with 0.5 percent in 2020 and a 0.2 percent average yearly rate of increase between 2015 and 2019. The price deflator for the consumer part of the gross domestic product, the Fed’s preferred inflation measure, has risen at a 5.4 percent annual rate so far this year, up from 1.4 percent in 2020 and an average yearly rise of 1.3 percent between 2015 and 2019. Oil prices have risen to levels seen only briefly during the last five years. Metals prices are also up sharply, while supermarket chains are stocking up on extra inventories to get ahead of rapidly rising food prices.
The stakes are high. Inflation, once it embeds itself in people’s expectations, distorts everything in the economy, none of it to any good. At the most fundamental level are the uncertainties it fosters about the future value of anything denominated in dollars. Planning becomes impossible. Businesses become reluctant to make the long-term investment decisions on which economic growth depends. Inflation takes on a life of its own as wage demands build in expectations of the future cost of living increases, and pay agreements assume that rising prices will compensate for inflated wage hikes. This self-sustaining pattern makes any efforts to ease the pressure that much more difficult. Stocks, bonds, and other financial instruments are denominated in dollars, which means investors see them in favor of assets that they believe will rise in value with the inflating cost of living. These assets consist mostly of real estate but also gold, other commodities, art, antiques, and the like. Perhaps today’s real estate surge is a sign that this kind of unproductive adjustment has begun. The flight from financial assets pushes up long-term bond yields and depresses stock values. As a result, businesses face an additional reason to pass on capital investments. All of this combines to detract from long-term growth prospects.
In their easy dismissals, Powell, Yellen, and others in authority hardly note these dangers. They seem to think so little of the matter that rather than present a coherent economic argument to explain themselves, they have offered Congress and the public little more than a grab bag of points designed less to provide answers than to deflect questions. They have, for instance, referenced a quick resolution of post-pandemic bottlenecks. As evidence, Powell has made claims that only a few sectors are driving broad price indexes upward. They have also noted that since the pandemic was having its worst effects last spring, any year-ago comparisons are misleading. They add that after the pandemic-depressed prices of 2020, the recent surge is simply putting inflation back onto its rather moderate long-term trend. Occasionally, those defending the lack of concern note that inflation fears have arisen off and on since the Fed adopted a very easy monetary stance during the financial crisis of 2008–09, and the feared inflation has never materialized. These points, though in most cases broadly true, fail entirely to address today’s concerns.
Instead, they verge on sophistry. Take the references to year-ago comparisons. Measures over the past twelve months are indeed distorted. But that says nothing about the severe inflation recorded over the past six months. As far as re-establishing a trend is concerned, there is no reason whatsoever to think that pricing in some tidy way strives to sustain any long-term trend. Inflation is just as likely to move along a new, steeper slope. Additionally, today’s inflation is not as concentrated as Powell claims. It is, in fact, broad-based by any standard. During the March-June period, for instance, only six of the twenty-three major subcategories of the CPI showed annual inflation rates at the Fed’s target of 2 percent or less. The other seventeen components show greater than a 2 percent rate of price gain, and twelve of them show annual inflation rates of over 5 percent, some considerably more. Though this evidence does not entirely discredit the supply chain arguments advanced by Powell, Yellen, and others or the expectation/hope that the inflationary pressure will peter out, it does cast doubt on the use of such arguments to dismiss people’s concerns, as these officials have.
At the same time, it is easy to discredit assertions by Powell and Yellen and recently voiced by Biden that this recent jump in prices was expected and “expected to be temporary.” If that were so, then why did the inflation not appear in the White House budget figures released only weeks ago? They put inflation for this year at a mere 2.1 percent, far below this “expected” reality. If this price surge was “expected,” then why did the Fed at the end of 2020 forecast 2021 inflation in the range of 1.4-1.7 percent? And if the authorities were on top of the situation, then why, when inflation’s reality left the Fed’s initial prediction in the dust, did the June estimate for this year put inflation in the range of 3.1-3.5 percent? The current pace of price increase would have to slow with remarkable suddenness to bring the year’s average anywhere near the Fed’s most recent estimates, much less those of seven months ago. These missed forecasts suggest that recent events were far from “expected” and that perhaps Washington’s experts lack the thorough understanding required to justify their glib dismissals.
Rather than avoid the inflation issue, Washington might do well to consider that the problem might reflect monetary policy mistakes dating back almost since the financial crisis of 2008–09. In the teeth of that crisis, Fed Chairman Ben Bernanke had little option but to pour liquidity into financial markets. Whoever was a fault for those strains, the financial system was on the verge of collapse, and should it fall, so would the economy. So the Fed brought interest rates down near zero and put funds directly into the financial system buying bonds outright on the open market, what the Fed called “quantitative easing.” If such extremes were called for in that unusual environment, then the Bernanke Fed embarked on the road to inflation by failing to unwind its earlier policy position when the economic and financial recovery gained a foothold in 2010. True, it was an extremely slow recovery that needed support and that also probably delayed any inflationary response to the flood of liquidity pouring out of the Fed, but monetary action was so extremely easy at the time policymakers had ample room to draw back without even approaching what might be described as a constraining policy.
Bernanke and others at the Fed were certainly aware of Milton Friedman’s warning of how inflation follows monetary ease with long and variable lags. Actually, Bernanke showed some sensitivity to Friedman’s insight by announcing in 2013 that policy would soon begin to taper the pace at which it was putting funds into financial markets. When investors immediately panicked in what Wall Street has come to call the “taper tantrum,” Bernanke lost his nerve and failed to change policy. When in 2014 Janet Yellen took over as Fed chair, she showed more stuff and began a very gradual shift in policy. Though Bernanke’s delay had already made her late to the game, she dared not move too fast, as the recovery was still slow and Wall Street, as ever, was still nervous. Under her, the Fed proceeded to change policy at a stately pace, and when Jerome Powell took over in early 2018, he continued that trend. To his credit, he did so despite tremendous pressure from the Trump White House to return to extreme monetary ease. But in 2019, the “trade war” with China either gave Powell genuine worries or provided an excuse to bow to the White House. Whatever his motivation, he re-established extreme monetary ease and then doubled down on it in the pandemic emergency.
The response to the coronavirus pandemic may have been warranted, but it also further advanced the inflationary impact building from years of earlier, excessive monetary ease. Now 2021 and in line with Friedman’s general prediction, the trillions of excess liquidity injected by the Fed into financial markets seem to be taking effect. All measures of money in circulation in the economy have soared. The broad M2 measure has grown at an annual pace of over 20 percent during the last eighteen months and inflation, as already described, has accelerated to rates not seen in decades. From this perspective, the inflation problem would seem to be baked into the economic cake and far from “transitory,” as Yellen, Powell and Biden claim. It is a frightening prospect, one of which several economists and financial analysts have warned over the prior, long period of monetary ease. A person can only hope that today’s Washington experts are correct and that Friedman was wrong. I, for one, fondly do hope that Powell, Yellen, and the president are right and that inflation fears are unfounded. Nonetheless, I have begun to adjust my investment portfolio.