Another Inflationary Impulse Strikes Consumers - June 14, 2021

The U.S. BLS reported last week that the Consumer Price Index (CPI) rose 0.6% in May, topping the forecast by analysts of 0.4% (Investor’s Business Daily).

The core CPI, which excludes food and energy, rose 0.7%, ahead of the forecast of 0.4%. In April, the indexes rose 0.8% and 0.9%, respectively.

April and May’s increases in the core CPI are the biggest gains since the early 1980s.

Clearly, the acceleration in inflation is stronger than had been expected. For now, however, most of the increase seems tied to the reopening of the economy and catchup.

For example, airfares (0.7% of the CPI) and hotels (0.8% of the CPI) are playing catchup. Despite recent increases, the CPI hotel category remains 3% below its January 2020 reading, and airfares remain 12% lower, according to CPI data from the St. Louis Federal Reserve.

Used cars and trucks (3% of the CPI), however, are up nearly 30% amid a shortage of autos.

It gets back to strong demand and the major disruptions in supply chains for many manufacturers, both of which are pushing prices higher.

Figure 1 illustrates what is happening. Consumer goods, excluding food and energy, account for 20% of the CPI. Prices have soared over the last 2 months. Price hikes in services (60% of the CPI), however, have been much more muted.

There had been some talk that if inflation looked too strong, we might get hints from the Fed at its Wednesday meeting of a more rapid withdrawal from its easy money policy.

Powell’s thinking

We achieved what could be called full employment in the last cycle without creating inflation, as firms mostly absorbed wage hikes, and commodity prices were behaved.

In Fed Chief Powell’s view, this gives the Fed the freedom to pursue a very easy policy as it coaxes the economy back to full employment.

However, today’s recovery is far different from the last cycle’s more gradual expansion.

Massive fiscal stimulus, coupled with reopenings and relaxed distancing restrictions, has spurred huge gains in spending. Manufacturers and supply chains, which have been hobbled and are still hobbled by the pandemic, are having trouble meeting demand. Hence, we are seeing big gains in prices.

Powell’s gamble: despite the big increase in prices, the outsized burst in inflation is temporary. If the Fed reaffirms its view that recent price hikes are mostly catchup and transitory, it’s unlikely to have any near-term effect on the Fed’s easy money policy.

Besides, the Fed has stressed that full employment is a condition that must be met before it raises interest rates.