All Posts Tagged: consumer price expectations

Too Early to Worry About Higher Inflation

Scott Anderson
Chief Economist

The fear of higher inflation has captured the imagination of consumers and investors in recent months.

After a very brief concern over deflation in March as the pandemic took hold, consumers have noticed rapidly rising prices at grocery stores, auto dealerships, health care providers, and at the gasoline pump, just to name a few categories.

The August Consumer Expectations Survey from the New York Fed revealed a big jump in consumer inflation expectations as consumers increasingly believed the current trend of higher inflation will continue over the next twelve months.

At the same time, investors have noticed the Fed’s monetary policy of asset purchases that near-zero interest rates have led to an explosion of money supply growth unseen in more than 50 years. In August, the M1 money supply, which includes currency, demand deposits, and other checkable deposits, was nearly 42% above year ago levels. Milton Freidman, the well-known Monetarist, famously stated that “inflation is always and everywhere a monetary phenomenon.”

This is largely how it is still taught in Economics 101 classes. Financial price inflation is certainly visible today in the traditional inflation hedges such as gold, home prices and equities. However, more recent economic research has shown that changes in the monetary transmission mechanism since Freidman’s time and underlying structural changes in the economy itself, puts Friedman’s monetary-inflation doctrine in bad need of an update.

If the U.S. economy were operating at full-employment, I would be much more concerned that the explosive growth in the money supply could stoke an inflation tsunami. But there is still a tremendous amount of slack in both the labor market and in the overall economy that will continue to put increasingly strong downward pressure on wages and prices in the quarters ahead. We still have nearly 30 million American’s collecting some form of unemployment benefits. This number has barely budged since May and has actually risen by more than 2.5 million people over the last two weeks.

Moreover, fixed income investors concerns over inflation may have already peaked. The lack of a new fiscal stimulus bill and increasing signs that the reopening growth spurt could be ebbing has gotten bond investors to walk-back some of their accelerating inflation bets.

In addition, investors appear unimpressed with the Fed’s new “average inflation targeting” framework rolled out to the public on August 27th. Bond market inflation expectations had been rising in anticipation of the Fed’s framework announcement, but quickly reversed course after the Fed’s new monetary framework was revealed.

Perhaps some investors were expecting the Fed to raise the inflation target above 2.0% or even announce some new monetary policy tools to help them achieve their new long-term goals. But since the Fed has already shot much of its monetary policy ammunition already, investors are bracing for very little change in the monetary “status quo.”

Finally, the Fed and investors have been here before. Investors were hedging for higher inflation in the early years after the Great Recession only to see those bets go bust when inflation never materialized. Economists have pointed to excess global savings, globalization, demographics, and technological change as reasons why low levels of unemployment and monetary easing has been unable to stoke a higher inflationary environment since 2009.

In short, higher inflation may eventually be sustained, but it’s way too early to prepare for that economic future. A shortfall in aggregate demand, high unemployment and intensifying deflationary price pressures remain the primary concern ahead.

To learn more, check out this week’s U.S. Outlook Report.

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