When Covid-19 infiltrated America, the economy was challenged with a black-swan even which nearly crippled it. If not for historic government stimulus it would have likely buckled under the weight of pandemic induced closures and restrictions. But government intervention allowed the economy to endure the worst of the pandemic until states began to gradually reopen.
Now, with increased vaccinations and easing of government restrictions, the US economy is reopening. However, with supply lines disrupted from the pandemic and demand likely to sky rocket for goods and services not enjoyed by much of the country for over a year, the specter of inflation looms large over the economy.
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
Is inflation a good thing? In moderation. As of 2020, the Federal Reserve has set its sights on achieving 2% annual inflation over the long term. While it may seem counter-intuitive, inflation in small doses is a good thing. The central bank notes moderate inflation is necessary in maintaining maximum employment and healthy interest rates:
“If inflation expectations fall, interest rates would decline too. In turn, there would be less room to cut interest rates to boost employment during an economic downturn. Evidence from around the world suggests that once this problem sets in, it can be very difficult to overcome. To address this challenge, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation modestly above 2 percent for some time.”
Now that states are mostly reopened to full or nearly full capacity, the question of inflation has taken front and center with economists, investors, and the Federal Reserve. Many agree that inflation in 2021 will likely exceed the Fed’s annual 2% target, but consensus cannot be reached as to whether higher inflation rates will be long lasting or merely transitory.
A recent Bloomberg article by Reade Pickert and Vince Golle acknowledges that demand for goods and services bottle-necked under Covid restrictions is likely to send inflation higher in the short term for 2021:
“Americans are likely to see prices jump across a variety of sectors next year, thanks in part to Covid-19 vaccines that will potentially turbocharge demand for such pandemic casualties as travel and tickets to sporting events.
With prices also climbing for some inputs such as copper and lumber, inflation could very well reach or surpass the Federal Reserve’s 2% target in some months.”
But one key factor in the macro-economic environment which the Bloomberg writers foresee as preventing a hyper-inflation scenario predicted by some is that of employment.
The article notes that in 2019, inflation reached higher than anticipated levels but employment was far tighter than the current post-pandemic economy:
“At 6.7% in November, the jobless rate is almost twice as high as it was in the closing months of 2019, when it stood at a five-decade low of 3.5%. Yet worker compensation costs decelerated then.”
In theory, a weaker labor market would have a deflationary effect on the rising demand from consumer spending. But as noted by The Balance, inflation in the month of May reached more than double the Feds 12-month target:
“The U.S. inflation rate as of May 2021 was 5.0% compared to a year earlier. That means consumer prices increased by more than 5% over the course of a year—the sharpest such increase since August 2008.”
The increase was most heavily weighted to the rise in used auto and food prices.
Which direction inflation in the United States economy takes over the remainder of 2021 remains to be seen. Forbes notes that neither the market nor the Federal reserve seem particularly concerned with long term inflation over the 2% target. This view is anchored by the current price of 10-year Treasury yields, trading at just under 1.5%, and the Federal Reserve’s continued Quantitative Easing campaign & unchanged interest rates.
Ultimately, US inflation data over the last 10 years shows that inflation has only gone over 3% for the calendar year once, in 2011. However, April & May both show inflation rates over 4%. But remember, Bloomberg’s position: a weak labor market will likely reign in consumer pricing over the long haul. Will high inflation only be a temporary glitch instigated by pent up post-pandemic demand and reduced supplies, or will the United States enter a period of stagflation marked by poor employment and sky-rocketing consumer prices? At the moment, only time can tell.
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