Thoughts on Inflation
By: Greg S. Hansen, Vice President & Managing Director of Trust Investments
This past week, the government released data on consumer and producer price inflation for April. The prices paid by consumers rose 4.2% over the past year and the price increases experienced by producers rose 6.2%. Those figures, however, only tell part of the story. Prices for both labor and commodities like gasoline and lumber are rising more quickly than the headline figures reported by the Bureau of Labor Statistics.
While it is shocking to see the numbers on paper, we have been anticipating an uptick in inflation based on the surge in economic activity and the low comparisons from last spring. Just over a year ago, large swaths of the economy were forced to mothball as government-mandated shutdowns took hold. At that time, prices declined at unprecedented rates. The November approval, and the subsequent rapid uptake, of vaccines brought about a fast restart of the economy. Add in lingering trade disputes, demand-induced supply shocks in the semiconductor and auto industries, and a winter storm that walloped much of the domestic plastics industry, and it is understandable that inflation is picking up.
Most people fear inflation and rarely is it painted in a positive light. Consumers lose purchasing power during inflationary periods. Corporations experience price increases that they may not be able to pass on to customers. In extreme cases, uncontrolled inflation can lead to civil unrest. At this point, the Federal Reserve seems content to simply monitor this inflation outbreak, calling it “transitory.” Later this week, we hope to get more clarity on the meaning of transitory inflation when the Federal Reserve releases the minutes from its April policy meeting. Until the Fed clarifies what it means by transitory, the rest of us are left to speculate about its definition.
Rather than waste time on that fruitless venture, we have decided to focus instead on the idea that inflation is a negative force in the economy. Granted, those with fixed incomes, limited wage growth, or few assets usually bear the brunt of inflation. However, we believe inflation, so long as it remains modest, is a necessity in a well-functioning economy.
To illustrate this point, think for a moment about an alternative scenario in which prices remain unchanged or, even worse, decline. Rational consumers will delay purchases of non-necessities as they expect the prices to be lower in the months or years ahead. Think what would happen to the economy if everyone who is in the market for a house or car decided not to make those purchases this year, but to wait for a year or two. The impact would be disastrous.
At least since the financial crisis of 2008, the Fed has been dealing with deflationary pressures, whether from consumers fearing a return to those economic conditions or from technological innovations making so many of the goods and services we consume less costly. The Fed has tried many iterations of quantitative easing in recent years with a goal of stabilizing the economy and stoking modest inflation. Despite an expansion in the Fed’s balance sheet of more than 800% since the Great Recession, it has consistently remained below its stated target range of 2-3% inflation.
In moderation, inflation gives consumers motivation to spend their paychecks now rather than wait. It gives them hope that their wages will increase in the future which, in turn, gives them confidence to commit to a fixed payment on a house over the next 15 to 30 years. Over time, inflation makes that monthly payment a smaller portion of their budget, allowing them to spend more of their income on other items. Without inflation, the velocity of economic activity will decline. Once a decline occurs, it has proven to be extremely challenging for the Fed to restart economic activity. It is far easier from the Fed’s perspective to slow inflation by tightening policy than it is to restart an economy by easing.
Make no mistake, inflation is inflation whether the Fed defines it as transitory or not. Nevertheless, at least at this moment, we agree with the Fed’s stance of not overreacting to the first signs of inflation. We believe the Fed has the tools to slow an overheating economy should it need to use them but, thus far, it has not proven an ability to restart a sluggish economy. A modest bout of inflation may be just the cure the doctor ordered.
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