INFLATION: New for some, old for others

So far, 2022 has been marked by war, lingering pandemic, energy/food shocks, robust labor markets, record quits rate, falling equity prices and inflation rates not seen for generations. For people who remember the '70s there is a sense of deja vu, but for those under about 55, this is a new experience.

Labor markets have recovered from the brief-sharp recession in the spring of 2020 and output recovered by mid-2021. Prior to Feb. 24, 2022, the expectation for the U.S. economy was that real GDP would grow more slowly than 2021’s 5.7% — given the fading effects of the fiscal stimulus (stimmies and all that), tightening in monetary policy, the labor constraint and the rising commodity prices. Inflation was expected to moderate with the improvement in the supply chain.

The inflation rate measured by the consumer price index has been rising year over year by more than 8% with soaring prices for energy, food, airfares and used cars for a while, to give a few examples. The elevated price pressures are happening in many parts of the world. (Britain 9%, Euro Area 7.4%, Canada 6.8%) Gas prices have become a feature of the nightly news with young reporters standing in front of $4-$5-$6 gas price signs. (Always a great visual!) There are a number of factors involved in the emergence of inflation at current levels — Pandemic, Policy, War and Weather (P2, W2) stand out.

The pandemic, now in its third year, has disrupted supply chains impinging on the ability to produce and distribute. There have been widespread shortages, transportation difficulties, Chinese lockdowns and worker absences. This puts upward pressure on prices when curtailed supply meets strong demand. This inflation component should decrease over time. This would fall into the transitory category that the Fed emphasized early on. Russia’s war in Ukraine is a global supply shock given the importance of the region for the production and export of wheat, corn, fertilizer, oil, gas and nickel. The sanctions, and the blockade of Black Sea ports unraveled long-term patterns and sent many commodity prices soaring. Energy prices which had been increasing with the rebound before the war spiked further.

Policies were put in place to mitigate the pandemic’s impact including the Cares Act, Omnibus Covid Relief Act, American Rescue Plan, the Fed’s interest rate actions and Quantitative Easing which entailed the purchase of $4.6 trillion in Treasurys and mortgage-backed securities. Individuals, businesses and state and local governments were supported. The policies continued after the problems had changed-crucial in 2020 became excessive in 2021-22. Other policies like tariffs, discouragement of fossil fuel investment and shutting nuclear plants in Germany put upward pressure on prices here. Weather always delivers shocks, the drought in the west (not in Cd'A this spring!) and parts of South America (Brazil, Argentina and Paraguay) impact commodity supplies. Failure of wind energy supplies in Europe boosts demand for natural gas and coal globally. The weather events happen all the time, but the coincidence of war, pandemic and policy errors heighten the impact.

The Federal Reserve is now focused on inflation. There have been two Federal Funds rate increases: one in March and one in May with the promise of two more 50 basis point increases to come. The Fed balance sheet is being unwound with $47.5 billion of securities proceeds not being reinvested in June, increasing to $95 billion by September. Interest rates have risen sharply with mortgage rates moving about 5% from less than 3% last year. Some will recall Fed Chairman Paul Volcker’s announcement in October of 1979, amid double-digit inflation, that this would end.

The tightening monetary policy and expectations of more have impacted financial asset prices (forget Your Q1 statements), housing markets-pending sales, and existing home sales have softened nationally. The dollar has strengthened. Fed actions with a lag, along with supply chain improvement will help moderate inflation. The most recent New York Fed Survey showed median consumer expectations inflation of 6.4% for one year and 2.9% for five. The war, weather and pandemic are still wild cards. Expectations for slower growth in 2022 have increased with the slowdown now anticipated to be greater, accompanied by inflationary pressures that last longer. The question is whether or not this will be the proverbial soft landing that the Fed hopes for or something more serious. We will know the answer in 2023 or 2024.

Press contributor John W. Mitchell was a professor of economics at Boise State University for 13 years before joining U.S. Bancorp in 1983. He was Chief Economist of U.S. Bancorp until July 1998 and served as Economist Western Region for US Bank until July 2007. A resident of Coeur d'Alene, Mitchell has been making economic presentations on the nation and the region for almost 50 years.