Rampant Inflation Worries Not Overstated
October 13, 2022
Financial markets again reacted very fearfully to a U.S. consumer price report. The 8.2% 12-month rate of increase in the total CPI was in fact down from 8.3% in August, 8.5% in July, and this year’s high of 9.1% in June. Core consumer price inflation, which excludes the volatile food and energy items, did go higher, although by just 0.3 percentage points to 6.6%. These measures are above the Federal Reserve’s preferred price measure, the personal consumption expenditure deflator, which in August posted on-year increases of 6.2% total and 4.9% core. Perhaps it’s fair to wonder if equity market selloffs might be over-reactive. I don’t think they are.
For one thing, inflationary impulses are spreading to more categories. Energy was the initial major driver and still shows a September-over-September advance of 19.8% despite a monthly 2.1% drop. Food inflation keeps worsening, with monthly increases of 0.8% in both August and September and a double-digit 11.2% increase over the last twelve months. Most worrisome, service sector price inflation, which have more inertia than goods prices, advanced by 6.7% over the past year. Wage inflation remains at 5%.
From a central banker’s point of view, it’s not just the level of inflation that counts. Inflation measures the rate of change in prices. Monetary policymakers must be vigilant whenever that rate exceeds target by a significant margin, but the policy response to above-target inflation also ought to be calibrated proportionately to how rapidly the deviation from target is widening. In the 28 months from May 2020 when CPI inflation was 0.1% to last month when it was 8.2%, the rate of inflation accelerated by 8.1 percentage points. Not in almost a half century has such a large rise in the U.S. inflation rate been experienced. The period between September 1972 when CPI inflation printed at 3.2% and January 1975 when it was 11.8% was the last time when the rate of inflation accelerated faster than now in a 28-month span of time. That period included the first OPEC-engineered oil price shock (a quadrupling of the price), and it preceded the start of Paul Volcker’s term as Fed Chairman by three to five years.
By examining the change of inflation over a two year-plus time span, the above exercise filters out short-lived supply shocks, and one can conclude that an enduring return to price stability probably isn’t going to be achieved simply by a slowdown of U.S. and global growth. Monetary policies must be seen to be attacking the problem and doing so even as inflation begins to show signs of responding to the medicine. The juxtaposition of the current inflation rate not just in the United States(8.2%) but also in Euroland (10%), Britain (9.9%), and developing economies like Russia (14.3%), Turkey (80.2%), or the Czech Republic and Poland (each at 17.2%), a three-percentage point rise so far of the Federal funds rate to 3-3.25% with U.S. unemployment super low at 3.5% doesn’t quite seem sufficient for the task ahead. The Fed should have gone farther.
When the Federal funds target was doubled to 6.0% in 1994-5 in the space of a year, CPI inflation never got above 3.0%. U.S. officials were handicapped by an historically low nominal and real rate level when the current tightening began. As always, the operation began with small bites, and the process has been gradual, sticking to pre-scheduled meetings to allow time to gauge the economic and financial market responses and to satisfy the desire for transparency. Just possibly, given the very long and variable lags between an interest rate change and those reactions, officials should have begun with a demonstration of monetary shock and awe that could then be gradually throttled back in later but smaller-sized moves if such proved necessary. In any case, financial markets are now waking up to the realization of how hard and long it will take to return to 2% inflation, and the sell-offs don’t seem excessive.
Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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