Fear of Inflation Can Make It Happen

Consumer prices surged in April and some commentators sounded inflation alarms. Others shrugged. Both reactions miss the mark. Neither panic nor nonchalance are justified.

The consumer price index grew at a 4.2% annual rate, the fastest in well over a decade. Some observers argued that the spike was driven by quirky and transitory factors and therefore should not be seen as a portent of sustained, damaging inflation.

They were right about the quirks. But that doesn’t necessarily mean there’s nothing to worry about.

The Labor Department statistics make it clear that the price jump was driven by one-off circumstances that are unlikely to persist. For example, the price of used cars and trucks soared 21% relative to April 2020. Compared to last month, prices for used vehicles grew by 10%, the largest one-month increase since government data on their prices began to be collected in 1953. This may have been driven in part by a shortage of computer chips needed to make new cars, fueling demand for used vehicles.

In addition, prices in April 2020 were very low due to the onset of the Covid-19 pandemic and lockdown measures, growing at only 0.3% relative to April 2019. So the April 2021 reading is relative to a month with unusually low prices, making inflation look worse than it is.

But as a means of assessing whether inflationary pressures are persistent or transitory, pointing to these idiosyncratic factors isn’t pointing to much.

Any period of sustained inflation is likely to begin with aberrant economic phenomena. The pattern takes months to emerge. In April, a fluke in the semiconductor supply chain sent the price of used cars soaring. Maybe this will return to normal in May, but then a transportation problem could suddenly push up the price of meats and eggs. Imagine that June brings them back to earth, only to see the cost of children’s clothes going through the roof. July and August each have rapid price growth, as well, for their own quirky reasons.

Inflation skeptics seem to think that explaining the quirks dismisses the problem. It doesn’t. The relevant issue isn’t whether one-off factors explain any one month’s data. Instead, the question is whether the accumulated effect of several months of price spikes — each driven by unique factors — leads consumers, workers and businesses to change their expectations about the pace of future price increases.

At some point, workers might have lived through enough months in which temporary factors drove up the price of a handful of goods or services that they knock on their boss’s door and demand a raise. At some point, businesses might have had one too many one-off hikes in the cost of things they need that they raise the price of what they’re selling.

When workers and businesses start thinking this way, the economy is in danger. Wages and prices start to rise across the board in a damaging and self-sustaining spiral driven by expectations of more of the same.

It is too early to know whether that will happen. But if it does, then a month like April will be seen in retrospect as the beginning.

How would the U.S. know if it was entering such a period? First, consumer prices have to remain elevated over at least the next several months. If monthly inflation data returns to normal, then much of the concern will evaporate.

I’m keeping my eye on wages, which grew at a 9% annual rate from March to April. If wages keep growing at that rate, it will be hard for businesses to keep prices from expanding too fast.

Surveys of households show elevated expectations about future inflation, but not troublingly so. Investors’ expectations about inflation can be read from bond market transactions. There’s evidence in these of rising inflationary expectations, but not to especially harmful levels.

The upward trend in investors’ expectations, however, does not look good. Markets expect 2.7% inflation over the next five years, up from around 1.6% prior to the pandemic. If that trend continues, concern about persistent inflation will continue to grow, financial markets will become increasingly volatile and the Federal Reserve will find itself in difficult situation.

I’d still bet the inflation genie will stay in its bottle. But the size of the price surge in April makes me a bit more worried than I was beforehand. And the fact that April’s spike came from a one-time increase in the price of used cars doesn’t do anything to calm my nerves.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and Arthur F. Burns Scholar in Political Economy at the American Enterprise Institute. He is the author of “The American Dream Is Not Dead: (But Populism Could Kill It).”

©2021 Bloomberg L.P.

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