Policy makers should stop apologizing. Inflation was really “transient”
Hot dog sausages are seen in a supermarket in Los Angeles, California, May 27, 2022.
Lucy Nicholson | Reuters
In the immortal words of Alanis Morissette: Isn’t it ironic that just as policymakers from President Joe Biden to Treasury Secretary Janet Yellen and her successor at the Federal Reserve, Jerome Powell, are all presenting apologies for misinterpreting the economic tea leaves, inflation is probably peaking even as I write?
The diverse and varied mea culpas, action plans to fight inflation, and massive criticism from policymakers who had virtually no control over the underlying events that caused consumer price spikes, could well look pretty silly in just a few months.
It could be that inflation is, in fact, transitory after all.
And by transient, I mean a year or two, not a month or two, because many misinterpreted the Fed’s choice of words last year.
If history is any guide, the spikes in inflation that follow massive disruptive events, like World War I and the “Spanish Flu” or World War II, last for a few years before plunging again once the supply and demand have rebalanced.
History of inflation peaks
I have long maintained that this the most recent experience with rising inflation (and no, it’s not near a record high), looks much more like a post-war experience than the sustained inflation of a more modern vintage that really started to pick up speed in 1968 before peaking in 1981.
According to the Minneapolis Federal Reserve, which keeps inflation histories on its website, post-war inflation spikes were extremely largebut relaxed when the world returned to normal.
When the United States entered World War I in 1917, inflation soared to a rate of 17.8%, followed by 17.3% in 1918, and then 15.6% in 1919.
By 1920, inflation plunged, dropping nearly 11% and remaining dormant for several years.
Similarly, in the years following World War II, inflation soared to 8.5% in 1946, 14.4% in 1947, slipping to 7.7% in 1948 and contracting 1% in 1949. .
The widespread nature of the global Covid pandemic and the subsequent shutdown of the Chinese economy, coupled with Russia’s largely unforeseen invasion of Ukraine, have wreaked havoc on global supply chains as we know well, disrupting shipments of raw materials and finished goods that have gone long beyond any reasonable assessment of conditions on the ground in early 2021.
But we are starting to see signs of normalization, as China prepares to reopen and the world, including OPEC, takes steps to reverse the damaging effects of the Russian invasion on food prices and Energy.
Inflation breakevens, a measure of the bond market’s expectations of future inflation, have reversed sharply.
Core inflation measures, excluding food and energy, stagnated.
With the exception of energy products, other commodities such as lumber, corn, wheat and soybeans have either collapsed, as in the case of lumber, or started to roll over. in the case of agricultural products.
In the meantime, the sticker shock in the accommodation has started to wear off…at least a little. More and more new homes are coming onto the market as home sellers begin to reduce asking prices to attract more cautious buyers.
Used car prices have moderated and waiting times for buying a car have started to decrease. Retailers are grappling with bloated inventories as consumers have changed their shopping habits recently, suggesting retailers may be slashing prices of goods just to get them off their shelves.
Companies, still reeling from labor shortages, are investing heavily in productivity-enhancing technologies, from robots to AI programs, while layoffs are just beginning to rise.
Inflation has peaked, the Fed should react
Very few policy makers are prepared to predict a spike in inflation, just as they were also reluctant to better define the notion of transitory in a historical context.
In my humble opinion, inflation has peaked. 2023 prices will drop from current levels.
The Fed, by the end of this year, will have done its job of reducing normalized demand to meet temporarily constrained supply.
I bet the Fed isn’t pushing the fed funds rate, the short-term rate over which it has the most control, above 2%. I also believe that quantitative tightening (reducing the size of the Fed’s balance sheet) will be a short-lived experiment in further tightening credit conditions.
Monetary policy, as I have argued recently, is no longer working with “considerable lag”, as many suggest.
Interest rates rose at a record pace in the first quarter of the year, while the dollar unexpectedly strengthened further.
The markets, and the real economy, very quickly adapted to developments both The Fed’s commentary and its actions, and ripped much of the excess from domestic and global stock markets.
Witness the fall of lavishly valued mega-cap tech stocks, or “meme stocks,” and cryptocurrencies, their associated exchanges, NFTs, and emerging market investments.
The Fed should take a break in September to reassess the direction the economy is taking now that the economy appears to be slowing and inflation appears to be, again, in my view, peaking. There may be another summer of discontent on Wall Street, but come fall, I suspect, there will be no more downfalls.