Federal Reserve monetary policy makers are caught between elevated inflation and a recovery whose pace, while still robust, has been slowed by the COVID delta variant.
Forces moderating the rate of economic growth—for example, shortages of basic items such as semiconductors and polymers and global transportation bottlenecks—also contribute to surging prices. Accommodative monetary policies can’t fix shortages, but those can boost demand and exacerbate inflation.
Chairman Jerome Powell remains confident the recent surge in inflation is transitory and is giving the economy a bit more slack. The Fed won’t begin tapering asset purchases until at least November and won’t start raising target interest rates until at least the second half of next year.
The Fed has consistently underestimated the duration of the post-shutdown inflation surges and a healthy dose of skepticism is in order.
The critical question he inadequately addresses is: Will the world, and in particular, the structures of consumer demand, supply chains and underlying cost pressures reasonably return to pre-pandemic patterns?
Durable goods—appliances, computers and the like—became cheaper in recent decades and that compensated for the shift to a more service-oriented economy—services tend to exhibit more inflationary pressure. But during the pandemic, surges in demand—work-at-home inspiring upgrades in residential offices and the like—and shortages of critical components have driven prices of durable goods higher.
The resurgence of COVID in Asia demonstrates North America and Europe have become too vulnerable to production disruptions and weak public health systems. Hardening supply chains and shrinking working-age populations in Asia are limiting opportunities to access low-wage labor. Businesses, such as auto makers, are seeking to diversify and better secure supply chains, and that implies a movement away from least-cost solutions and more price pressures.
Also, going forward government policies to accelerate decarbonization will increase manufacturing costs—electric motors and batteries systems are more expensive than internal-combustion powertrains.
Finally, the labor market is already tight with nearly 11 million unfilled jobs and vacancies in manufacturing are about double pre-pandemic levels despite the fact that the economy still has not regained millions of jobs lost in the COVID shutdown.
Concern is emerging among top manufacturing executives that these conditions are becoming structural—not transitory. If inflation becomes built into their thinking and tight labor markets persist, wage-price spirals could emerge that bouts with inflation in the 1970s teach are difficult to break.
Administration stimulus polices—well beyond the now-expired federal supplement to unemployment benefits—are discouraging work. For example, the means-tested Child Care Tax Credit, which provides $3,600 for children under six and $3,000 for those under 18 but declines as family incomes rise, provides a substantial subsidy to stay-at-home parents to mind the kids, especially in high income-tax states.
Expectations that the program will be extended by the reconciliation bill and supplemented with free pre-K education and two years of free college further enables stay-at-home parents to opt-out of the labor force.
New risks emerge
New COVID variants, even more contagious and resistant to vaccines, have emerged in South America and are finding their way into the United States and Europe. And the Evergrande crisis could further disrupt the Chinese economy—and further tighten the availability of goods and components in manufacturing elsewhere.
The magnitude of the consequences of these epidemiological and economic factors are terribly difficult to model but the general direction is clear. Should the economy slip again owing to further shortages of computer chips and all manner of other essential components, easy money will only further boost demand and push up prices. It won’t reopen factories, solve disruptions in supply chains or create jobs for the unemployed in public-facing jobs by sending folks with cash back to offices, restaurants and dry cleaners.
With businesses unable to find workers and households now expecting inflation to run above 5%, a wage-price spiral could easily ignite. As Powell likes to remind, it takes a good year for a change in monetary policy to influence inflation.
For now, it appears wages are not keeping up with inflation, and inflation affects poorer workers most. The items they buy most are going up the most and they have less latitude than richer folks to substitute among products or save less.
Hesitating now to taper can only fuel inflation, do workers little good and risk persistent runaway inflation that would ultimately require the kind of draconian tightening Chairman Paul Volcker imposed in 1979 and into the early 1980s and a tough recession.
Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.