Four reasons to continue to worry about inflation

Federal Reserve Chairman Jerome Powell may have retired this term, but common sense still holds that much of the excess inflation in 2021 is temporary. Many economists and market watchers predict most of it will be gone by 2022. I am much more uncertain and predict the economy will experience high inflation this year, maybe even may be higher than in 2021.

The core consumer-personal-spending price index (which is, in fact, what the Fed is aiming for) has grown by about 4.5% in 2021. The median member of the Federal Open Market Committee predicts it. will slow to 2.7% while Fed staffers predict it will be even lower than the rate. Inflation-indexed bonds show that the market expects inflation of about 2.5% this year on a comparable measure.

Those who imagine lower inflation argue that a massive boom in fiscal policy is behind us, supply chains won’t work, consumers will shift from buying goods to services, Workers will return and prices of commodities like oil will continue to fall. Some of their arguments are exaggerated, while others may be false. And if we focus solely on the reasons inflation should be lower in 2022, we risk ignoring four opposing forces that will push inflation higher this year.

First, the economy is starting 2022 with the labor market much tighter than it was a year ago. In the two decades before the pandemic, the best predictor of next year’s inflation was the unemployment rate — the number of people leaving their jobs as a percentage of total employment. It is now far and far from the highest it has ever reached. A year ago, the unemployment rate showed a significant drop. Now it’s almost 3 percentage points lower. Nominal wage growth is outpacing productivity growth by about five points.

Second, demand should remain above pre-pandemic trends, while supply will likely continue to lag. Many analysts have believed in a substantial reduction in fiscal support to contain inflation. That dramatic drop is now eight months behind us with no sign of consumer spending cooling down. Financial assistance will remain relatively high, with more than $500 billion of Rescue Plan Americans spent this fiscal year. State and local tax cuts and spending increases, along with huge surpluses, are adding to fiscal support. Adding to the lagging effects of extremely accommodative monetary policy, households with excess savings have had high incomes over the past two years and low spending, and employment and wages have grown rapidly, and you have a recipe for continuing to spend high. At the same time, supply chains will improve but are unlikely to fully recover for much of 2022.

Third, consumers, businesses, forecasters and financial markets all expect short-term inflation to be about 1 to 3 percentage points higher than a year ago. This will add to the rising inflation that the economy did not face last year.

Fourth, the trajectory of Covid and its effect on inflation is highly uncertain. If the pandemic turns into a manageable pandemic by 2022, that could boost inflation in the same way that the economy quickly reopens in the first half of 2021. If China manages to stay that way. zero Covid rates with populations effectively unvaccinated with Omicron, we could have the worst of all worlds as strong US demand drives global supply chains cracked.

The most reliable argument for reducing inflation is a shift in demand from goods to services. But this could help curb inflation much less than many are expecting. Most of the excess inflation in 2021 is due to rapidly rising commodity prices. That inflation will stay moderate and could even turn negative for key commodities like used cars. But service price inflation only needs to increase by 1 percentage point to offset the decrease in commodity inflation by 5 percentage points. Prices for services such as rent, air travel and hotels have increased in recent months and are likely to continue to rise.

The biggest mistake forecasters make in 2021 is trusting their erroneous predictions too much. The economy has always been unpredictable, and the current exceptional circumstances make it even more difficult. I expect inflation to be in the 3% to 4% range this year, but I wouldn’t be surprised if a recession leads to 1% inflation or major geopolitical uncertainty puts the inflation rate above 6%.

Mr. Powell was right to turn around inflation concerns in December. He has proven that the Fed’s actions will depend on the data and the Fed is now starting to raise interest rates in March. If inflation remains as high as I fear, let’s hope he continues to track the data by pivoting further. Given the uncertainty, however, he should stay the course — for now.

Mr. Furman, professor of practical economic policy at Harvard University, was Chairman of the White House Council of Economic Advisers, 2013–17.

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