OPINION: Some more talk about inflation risks

Thanksgiving at my home was a delightful affair. We enjoyed a large family gathering, well-seasoned with old and new friends. Nobody spoke of inflation, which is always a welcomed thing. In fact, my advice to anyone whose Thanksgiving table is despoiled by macroeconomics, is to establish hard fines for such talk next year. Still, there’s no way to avoid noticing a change in prices this season, and it is helpful to try to make some sense of the data.

A price increase is not inflation. We see them all the time, if there is a natural disaster or some other irregularity that disrupts supply. Prices go up when people are willing to pay more, such as for flights during the holidays or Florida rentals during spring break. We are used to seeing these and making adjustments accordingly. However, this time is different in a few important ways. 

First, we are seeing general price increases. We see them at the pump and the grocery and in wage increases for some types of workers. Second, these price increases are coming at the same time that the supply of money has increased substantially. Third, the labor force remains stubbornly lower than it should have been without the pandemic, which hints that it may actually cost more to produce and deliver goods and services. All told, this is a combination that spells growing risk of longer-term price increases, but there’s more to the story.

The price increases we now see are not themselves evidence of long-term inflationary pressure. Over the pandemic, household savings in the United States spiked. For two decades, the average savings rate hovered between 6.0 and 8.0 percent. During the pandemic it spiked to over 35 percent, and as recently as last spring was over 26 percent.

The pandemic caused most American families to cut spending on vacations, gasoline, new clothes, restaurants and the like. At the same time, the CARES Act rushed money into the hands of the unemployed and provided stimulus funds to working families and businesses. Over the past few months, families across the U.S. have been urgently spending that money. They’ve gone on vacation, visited restaurants and amusement parks, and bought RVs, boats and automobiles. The past few months have seen an unparalleled surge in demand for goods and services.

Businesses responded to this surge. U.S. manufacturing production hit an inflation-adjusted record in the summer of 2021, while imports of goods also hit a record level. The "supply shortages" that so animated the media occurred at exactly the same time we had record goods available to sell.

This present price increases are driven almost wholly by exhausting pent-up demand. Certainly some goods are hard to find, e.g. new cars. And, it is surely hard to find workers for many jobs; we’re still making, importing and moving more goods than at any time in U.S. history. So, inflation concerns focus on whether this is a permanent or transient phenomenon.

There are still plumper-than-normal savings accounts, but spending patterns are returning to normal levels, more or less. So, the biggest source of excess money seems to be moderating. I’ve even noticed gasoline prices moderating by a quarter a gallon over the past week. That is highly unusual during a holiday season, and is too soon to be a consequence of releasing the national petroleum reserve.

Black Friday and Cyber Monday had plenty of discounts, though it is too soon to know if those prices were contained to the holiday weekend or are more seasonal. As I write this, there are several days of broad price declines for most commodities, including oil, natural gas, precious metals, row crops, and livestock. Home price growth has also moderated significantly, as has the stock market. Of course, this might just be due to the Federal Reserve indicating its increased concern about inflation. The only prices to rise this week were for interest rate futures, a signal of heightened expectations of a Fed policy move to tighten money supply in the coming weeks.

For many months, worry about inflation has involved one of two scenarios. The first is that we saw an increase in inflation that is really just a one-time price increase. The second is that prices will increase, then increase again, and continue to grow for months or years.

If prices rise a bit, but just for a few weeks or months, we might end 2022 with price levels about where they would’ve been without the pandemic. In fact, if we look back over two years, the typical inflation rate is just under 3.0 percent, which remains historically low. But, if the current increase in prices gets built into labor contracts, new orders for equipment and buildings, then it will raise expectations of future inflation.

I believe the most likely scenario is that much of the current burst of inflation remains short term. I believe this because the horde of family savings caused by COVID will be depleted in the coming months, and I believe that the Federal Reserve will tighten interest rates in the first months of 2022. I also expect that the large Build it Back Better spending bill is no longer politically tenable. So, we will not be adding more fiscal fuel to inflation.

The most compelling evidence I have that longer-term inflation risks are low is that bond market activity does not indicate alarm. Markets for government and private bonds are the single most sensitive marker of inflation expectations. As long as the buyers and sellers of bonds continue to perceive the many ways in which today’s inflation appears transitory, the remainder of us can rest easy.