Federal Reserve Chairman Jerome Powell
Susan Walsh / Associated Press
Federal Reserve Chairman Jerome Powell’s inflation ship has arrived, albeit more rude than he probably wanted. The consumer price index rose by an impressive 4.2% annually in April and by 3% in the core measure excluding food and energy. Mr. Powell wanted more inflation, and now he has it.
The price hike won’t surprise most Americans who have paid more everywhere from the grocery store to cars to the real estate market. April prices rose across the board, especially for goods and services that were less in demand during the lockdowns. Hotel prices rose 8.8% month-over-month and 8.1% year-over-year. The monthly increase of 0.9% less food and energy was the largest since 1982.
With the introduction of vaccines, more and more people are going out and spending their savings and stimulus checks. At the same time, demand is increasing and companies are frustrated by supply problems. Used car and truck prices rose 10%, a third of the monthly CPI increase. One reason: New car production has slowed down due to the global shortage of computer chips. But that’s no consolation for middle-class Americans buying used cars. The rich buy new Teslas.
The prices of raw materials have also risen and are included in consumer prices. Corn prices are up 50% this year and 125% year over year. Overall, food prices rose 0.4% from March and 2.4% over the past 12 months. The prices for fresh produce and meat continued to rise.
Labor shortages are also driving wages up – the average hourly wage rose 0.7% in April – and could lead to higher consumer prices. Many small businesses were reluctant to pass on their rising cost of goods and labor when demand was lower. However, that may change now as consumers spend more money.
The innocuous explanation for the April price hike is that it is “temporary,” as Mr Powell likes to say. The April surge is akin to a fall in prices last spring at the height of the pandemic, and comparisons will look less ugly in the months ahead. Oil prices also hit lows last spring when demand fell. Remove those factors and the CPI spike is barely above 2%.
Vice Chairman Richard Clarida reiterated the Fed’s view on Wednesday that the economy is still a long way from full employment and that prices will weaken once supply problems abate. The Fed has announced that inflation will exceed 2% as long as it averages 2% over the long term and does not plan to adjust policy until the country approaches full employment, which has been the case in the past, which has been a moving Fed- Aim.
However, always and everywhere, inflation is a monetary phenomenon, as Milton Friedman put it. For more than a year now, the Fed has always pursued an expansive policy. In an economy that has been growing rapidly for more than nine months, the company has kept interest rates near zero and expanded its balance sheet to record levels with bond purchases. The Atlanta Federal Reserve’s GDPNow forecast for second quarter growth is 11%.
The money supply has grown rapidly, and cash seeks higher returns across the economy with interest rates close to zero. Junk bond issuance this year is at record levels. Asset prices have been booming. The danger is that expectations of higher inflation will rise and become embedded in business and consumer decisions. The impermanence then becomes longer and the Fed may have no choice but to end the party, perhaps more abruptly than it wants.
The risk is exacerbated by the political situation in the Fed, which was in part caused by Mr. Powell himself. The chairman cheerleaded for last year’s fiscal blowout, particularly Joe Biden-Nancy Pelosi’s agenda. The Fed has monetized almost all of last year’s new Bund issue, and the Democrats are counting on the Fed to keep them going for years to come. This makes it harder for the Fed to cut back on its bond purchases or raise interest rates.
Mr Powell will need the current surge in inflation to be temporary or he will find himself in a political jam if markets force him to tighten. Better for the Fed to reassert its independence by moderating its policies now than to risk more damage later.
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Published in the print edition on May 13, 2021.