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How we stopped inflation without a recession (hint: by not stopping inflation)
Do we really have no hangover after the largest economic orgy in history - more than $10 trillion in fiscal and monetary stimulus in 2020 and 2021? The charts below suggest we're still just drunk.
The inflation crisis is over.
Or is it?
This morning a reader sent along an interesting analysis of Thursday’s supposedly positive inflation report showing that prices in July rose 3.2 percent annually - and an even more interesting chart.
First a little background. That 3.2 percent number is “headline” or overall inflation. That headline annual figure peaked at 9.1 percent in June 2022 and has since fallen sharply. Thus the growing consensus that inflation is back in check.
But the “core” inflation rate tells a less optimistic story than the headline number. Unlike overall inflation, the core inflation rate excludes changes in food and energy prices, which can move quickly. It is less volatile than the overall inflation rate. This chart (not the one from the reader, wait for that) shows core inflation since 2018:
As you can see, core inflation soared in 2021, following the passage in March 2021 of a $2 trillion Democratic Covid spending bill. The connection is stunningly clear - links in economics are rarely this obvious.
Core inflation peaked in late 2022 following another massive stimulus package, which Democrats initially referred to as “Build Back Better” but then rebranded the “Inflation Reduction Act,” a masterwork of cynicism even by Washington standards. Since then it has slowly come down, as the Federal Reserve has sharply raised interest rates to slow the economy.
(NO INFLATION HERE, STILL $6 A MONTH)
Still, more than two years after taking off, core inflation remains far above the 2 percent annual level that the Fed and many economists view as the ideal long-term target. At 2 percent a year, inflation is low enough that most consumers will not notice it, but still far enough above zero to provide room to avoid deflation in the case of unexpected economic shocks.
(Policymakers dislike deflation because it can be hard to reverse. If money itself seems to be getting more valuable over time, people may take their assets out of the financial system and hold them in cash or gold, as well as delay purchases on the theory that they will be able to buy products more cheaply in the future. Companies may decide to delay hiring for the same reason. Central banks do not have great levers to reverse those decisions. Thus deflation can by itself harm an economy, as Japan has seen for much of the last 30 years. Low but stable inflation is preferred.)
Of course, Biden’s media cheerleaders, who wouldn’t even admit inflation was even an issue until it the headline number approached 10 percent annually, now say prices are under control. Yes, overall annual inflation is only about 3 percent now. But that’s because food and energy prices rose so much in 2021 and early 2022 and have come back down since.
The “headline” number exaggerates the trends on the way up and the way down. In fact, core inflation is still at almost 5 percent. And the longer it stays at that levels, the more people will expect it to go on and demand big wage increases to meet it.
In a tight labor market, companies won’t have much choice but to meet those demands. Then they have to raise prices to cover their increased costs. Seeing those increased prices, workers will demand more wage increases, and companies will agree - like the deal the Teamsters union reached with UPS last week, which increases the top compensation for drivers to $170,000 a year and offers part-timers a minimum of almost $26 an hour.
Economists call this a “wage-price spiral.” Once it happens in earnest it cannot be stopped until the labor market loosens up and employees have to fear for their jobs - that is, until the economy slows and unemployment rises.
Ultimately, this pattern is why inflation is so problematic. It is addictive, and breaking the addiction means damaging the economy.
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Now to this morning’s email and chart:
Food prices heading back up, energy heading back up, wages up (and likely to get worse post the UPS deal as others will likely have to follow – seems like a classic wage price spiral), producer prices back up (+0.3% MoM - biggest jump since Jan 2023), and somehow inflation has been slayed? We will see, hopefully we don’t find out the hard way…
Chart below shows the pattern in the 1970’s, overlayed with what is going on now. Same pattern. An apparent lessening in inflation, which is largely due to base effects and policy gimmicks, without solving the underlying problem, so inflation came right back (it really never left, the base effect just masked it). Everything about policy now remains inflationary, including the amount of government spending and other policy which just increases price…
(And, finally, the chart: The yellow line is overall annual inflation since 2013; the blue line is overall annual inflation between 1966 and 1982, the last time inflation was a problem in the United States. History doesn’t repeat itself, but we’ll see if it rhymes.)
With respect to energy, now that oil and gas are starting to become a problem again… all the sudden we get the Iran deal yesterday, the entirety of which seems quite odd.
Maybe I am just too cynical in my old age, but it seems this is just one more thing that is more about political expediency than it is sound policy. Metaphor for a lot of our problems. The issue is, we have more than used up the wiggle room to behave in a less than prudent fashion, and actually need to start doing the opposite and behaving like adults.
He’s right, of course. The federal government is committed to running trillion-dollar deficits as far as the eye can see, and that’s before the Social Security and Medicare sinkholes really open up. And though the Federal Reserve did move interest rates higher, it blinked and backed off as soon as stocks really came under pressure.
Maybe the optimists are right and inflation really is under control.
Maybe we managed a soft landing from what was a very, very high jump. Maybe the clear problems in the Chinese economy will lead to a worldwide deflationary spiral that will bail us out.
Or maybe we’re still just hoping for the best while still refusing to make any hard choices about taxes, spending, and how we manage the financial system.
We actually need to start behaving like adults.
I wish I believed we will.