Springtime for Inflation

Here we go again. Stock and bond markets have been volatile lately due to fears about inflation. I say fears, but perhaps uncertainty is the better word. Either way, there’s an ongoing and growing disconnect between how investors, central bankers, and ordinary folks think and feel about inflation.

Last week the Bureau of Labor Statistics announced that the Consumer Price Index had ticked up from last April to this April at the fastest rate since at least 2008. As usual, some parts of the economy were moving normally but others were ripping right along. Prices for used cars and trucks were up more in April than at any time since at least 1953. Airlines, recreation, and costs for housing and home furnishings also rose rapidly.

Much of this was expected following the one-year mark from the pandemic lows as year-over-year comparisons on all sorts of things started to show dramatic change. But many were wondering and worrying about the rate of change. Energy prices were up 25% from April 2020, but you’ll recall that the price of oil went negative for a short while back then and the industry was hammered. So, while 25% is a big increase, it’s from an extremely low level. The CPI also showed that hotels and car rentals were up huge in April compared with a year prior. Pent-up demand is a powerful force.

Not all prices rose dramatically. Food at home (versus restaurants, which rose faster), alcohol, apparel, and new vehicles were up a relatively modest 2%. All told, headline CPI came in at 4.2% from April to April. The “core” number that strips out volatile food and energy prices was 3%.

While those numbers might seem small, it’s a big change from where we’ve been. And you might report your personal inflation rate as being much higher. Also, you feel this surge of activity all around you and it makes sense that it would be inflationary. I mean, seriously, the government will have pushed trillions of dollars into the economy when all’s said and done. How can the Fed and others suggest that all this activity and corresponding inflation is only “transitory”? Two words: excess capacity.

(For reference, the Fed has targeted a longer-term average of 2% core inflation. We’ve been below this for so long that they’re willing to let things run hot for a while before trying to tap the brakes.)

The Fed has two mandates from Congress; to manage inflation and to shoot for full employment. Even with all the free money flowing into the economy helping to fuel demand, the Fed expects that the recent consumer spending spree won’t last long enough to be a problem. They’ve also been saying there’s room, or excess capacity, in the economy to soak this up. Millions are still unemployed and service workers, those near the bottom of the employment food chain, still aren’t fully back to work. In other words, everyone isn’t out there buying cars and booking hotel rooms. Until they are, at least from the Federal Reserve’s perspective, it’s much ado about nothing when it comes to last week’s inflation numbers.

Investors see it differently. Or, maybe it’s more accurate to say they don’t know what to think. We haven’t had to deal with an inflation problem for a long time. We also haven’t had a Fed this interested in propping up the economy. Then again, we haven’t gone through a Covid-level pandemic in recent history either. And millions of new investors have entered the markets and have mostly just seen things go up. So, maybe it makes sense that there’s uncertainty about the risks posed by inflation. It’s hard enough to understand the ins and outs of inflation in the best of times.

But what is inflation? Is it helpful or harmful? Is it something we actually need?

There are a variety of answers to these questions from diverse sources like bland Economics 101 textbooks to deep dives down the Bitcoin rabbit hole. But for a more straightforward conventional set of answers, here’s a few links from the middle of that spectrum.

The first is a video (about eight minutes long) from the folks who present Marketplace, a great program for distilling the complexities of markets and the economy down to something understandable.

Fun tip: try to watch the video without looking at the date. You might guess it if you stick around toward the end, but I’ll leave you to appreciate the irony.

https://www.youtube.com/watch?v=9sZdXJbK554

Here’s a short article that gets into why at least some inflation is necessary.

https://www.marketplace.org/2019/09/12/why-is-inflation-necessary/

Then here are two good articles from Schwab (one shorter, one longer) talking about the current outlook.

https://www.schwab.com/resource-center/insights/content/is-1970s-style-inflation-coming-back?cmp=em-QYD

https://www.schwab.com/resource-center/insights/content/world-inflation-transitory-or-more-nefarious?cmp=em-QYD

I’m purposefully leaving out the cryptocurrency stuff because it really is a rabbit hole. I don’t think that’s a bad thing, by the way, just that it’s way beyond the scope of this post.

Have questions? Ask me. I can help.

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