A statistical surprise and the rapid recovery of the economy have boosted the consumer price index, writes The Economist
In the spring of 2020, consumer prices in the US, fell for three consecutive months, due to the pandemic. Rental prices were lowered, hotel rooms were emptied and oil prices turned negative.
All the sudden outbursts of deflation or inflation appear in the news twice: when they occur early and a year later, when comparisons are made with 12 months ago. Statistics reported that consumer prices in March were 2.6% higher than a year earlier, from 1.7% in February. The rise in headline inflation was the largest since November 2009, when the same “core effects” were at play after the global financial crisis.
However, it would be wrong to dismiss the rise in inflation simply as a mathematical wonder. America’s economy is recovering from the rapidly declining trend as jobs recover and vaccinated consumers start spending again. In March alone, prices rose 0.6% from the previous month, the fastest pace since 2012.
Much of this was driven by a sharp rise in gasoline prices, but also the “core” consumer price index (CPI), which does not take into account food prices and energy prices, rose by 0.3 % (an annual rate of 4.1%).
Utility prices in particular have started to rise: hotel rooms were 4.4% more frequented than a month ago and rent, an element of the index, has risen sharply in recent months. Capital Economics predicts that the combination of base effects and the resurgence of the economy will lead to an annual inflation rate of around 4% by May.
The Federal Reserve targets annual inflation of 2%, but in the price index for personal consumption expenditure, which is usually about one-third lower than the CPI index. However, if prices rise at a monthly rate in line with the Federal Reserve target, as they have increased in recent months, thanks to the base effects, the target will soon be exceeded in annual terms (see chart). Any stimulus to the economy will lead to a further leap.
The direction that inflation will follow is more important than usual, due to the great economic uncertainty. The easing of social distancing restrictions, President Joe Biden’s huge $ 1.9 trillion economic stimulus, and the unusual softness shown by the Federal Reserve, which is pursuing a new monetary policy framework, all constitute an experiment with inflation.
It has turned some optimists into pessimists, and economists such as Larry Summers, the former secretary of state, and Olivier Blanchard, a former IMF economist, have warned of the risk of the economy “overheating.” As the Biden administration tries to pass infrastructure bills following economic stimulus, the outcome of this experiment will largely determine how much spending deficits the economy can afford.
The Federal Reserve and the White House expect any increase in inflation this year to be temporary. Financial markets are less secure. They are preparing for an extended period of inflation that will exceed the Federal Reserve target, and for the possibility of higher interest rates in 2022, although at the most recent meeting of the Federal Reserve in March, no rate hike was forecast. until after 2023.
The Central Bank’s view stems mainly from the state of the labor market, which has about 8.4 million fewer jobs than the level of employment in February 2020 and even much less than it would have been if the pandemic had not struck. . This slowness should keep inflation low.
However, investors can rightly question the forecasts of economists. The latter have consistently underestimated the pace of job returns in America. In the second quarter of 2020, the model from the Federal Reserve Bank of Philadelphia predicted that unemployment would average 11% after two quarters; but in fact, it resulted in only 6.8%.
This was the largest overestimation in the history of studies, with an error level three times greater than the second most erroneous prediction. In February this year, forecasters expected unemployment in the second quarter to average 6.1%, but it fell below this level in March. If the labor market continues to exceed expectations, the economy will slow down and inflation will rise faster.
The moment will come when the Federal Reserve will have to face an election. Its new monetary policy framework seeks to temporarily exceed the 2% target after the recessions, in order to make up for lost ground. But it has been unclear what this “average inflation targeting” means in practice.
Some officials say it means the Central Bank needs to make up for lost inflation since last spring. Others have hinted that August is the starting point for the loss compensation policy, because in this period the monetary policy followed changed. But since August, there has been no shortage of inflation. If the rise in spring inflation does not slow down, the Central Bank must decide what it wants to do.