Inflation: what lies ahead? – Knowledge @ Wharton


The latest inflation rate hike to 4.2% in April 2021 fueled expectations that the Federal Reserve could raise interest rates and tighten monetary policy. The rise in the consumer price index for all items is the largest 12-month increase since a 4.9% increase in September 2008, the US Bureau of Labor Statistics (BLS) reported earlier this month.

In recent times, the Federal Reserve has been willing to adjust to higher inflation, but that position could change with the unexpected pace of price increases in the latest data. “The Fed has sent fairly clear and strong messages over the past year or so, indicating that it will not be deterred by signs of inflation, that it will maintain loose monetary policy and maintain [interest] declining rates, ”said Itay Goldstein, professor of finance at Wharton, in an interview with the Wharton Business Daily Radio Show on SiriusXM. (Listen to the podcast at the top of this page.)

That position may now change as the inflation data for April “was quite alarming,” Goldstein continued. “No one really expected the inflation figure to be this high. So now we’re starting to see more hope that maybe the Fed will eventually act and start raising rates and tightening monetary policy. the federal funds target rate serves as a benchmark for bank interest rates and is currently between 0% and 0.25%. The Federal Reserve has said it plans to keep its benchmark interest rate close to zero until 2023.

According to Jeremy Siegel, a finance professor at Wharton, the Fed may have no choice but to raise rates. Siegel spoke of the threat of rising inflation over the past year, especially on the Behind the markets show that he co-hosts on SiriusXM, and elsewhere in media interviews. “We could have significant inflation in 2021 and 2022, causing a cumulative rise of around 15% to 20% in the price level,” he said. “We won’t have the chronic inflation of the 1970s. The Fed will be forced to raise rates. [President Joe] Biden’s stimulus, in addition to last year’s stimulus and monetary expansion, created a serious inflation situation. But the economy will remain strong. “

“The Fed will be forced to raise rates.” –Jeremy Siegel

Explaining a potential change in the Fed’s approach, Goldstein pointed to recent comments by Fed Chairman Jerome Powell that the central bank is not necessarily aiming for 2% inflation, but it wants to see 2% in. average over a period of time. The Fed is considering “a wide range of financial conditions” rather than a single measure, Powell said in a March 2021 statement. interview with the the Wall Street newspaper.

“[Powell’s comments] indicated even if [inflation] going above 2% temporarily, we’re not going to change monetary policy, ”Goldstein said. “So we expected the Fed to stick with it, keep rates low and maintain loose monetary policy.”

Clamping space

Powell had kept the door open to tighten monetary policy if warranted. “If conditions change significantly, the [Fed’s rate-setting] The committee is ready to use the tools at its disposal to further the achievement of its goals, ”said Powell in the the Wall Street newspaper interview.

Later in April, Powell reiterated in a letter to Republican Senator from Florida Rick Scott that the Fed would step in if the inflation rate remained above 2% for an extended period, Reuters reported. “If progress towards our employment and inflation targets slows, we will maintain a very accommodating stance longer,” Powell wrote in the letter. “Conversely, if progress turns out to be faster, adjustments to the policy direction will likely take place sooner.”

Although the pace at which inflation rose in April surprised economists, many had warned that price increases would follow the government’s COVID-19 stimulus programs and Federal Reserve interventions.

Since March 2020, nearly $ 10 trillion in coronavirus relief programs have been launched between the Trump administration and the Biden administration. They include a $ 2.2 trillion CARES program from March 2020, a $ 900 billion program in December 2020, and three Biden administration programs totaling more than $ 6 trillion.

The month of April was marked by sharp price increases in all areas, except energy. The consumer price index for used cars and trucks rose 10%, the largest monthly increase since the series began in 1953, and it accounted for over a third of all items , seasonally adjusted, the BLS said. Other indexes that had “a big impact on the overall increase” included food, shelter, airfare, recreation, auto insurance, and furnishings and operations.

Inflation trends have also challenged the wisdom of the market at other crucial times. “[After] the 2008 crisis and all the stimulus and quantitative easing that followed it, there was always this concern that inflation is going to appear as a result of that, ”Goldstein said. “And none of that happened – we didn’t have inflation.” The inflation rate in the United States fell from 1.3% in October 2006 to 5.6% in July 2008, before falling even more sharply to -2.1% in July 2009; since then it has remained well below 3%, according to BLS data.

“Now everyone is [waiting] to see what will happen next – whether it’s a temporary or more persistent change. ” – Itay Goldstein

This time around, the expectations were that the economy would be able to absorb the coronavirus stimulus funds and that “we may not be in a real danger of inflation,” Goldstein said. He noted that although the United States has experienced its inflation spurts in the past, “it has been a long time” since it happened.

“There was this debate, [where] people who thought we weren’t going to see inflation got the upper hand for a while, but the new data was definitely a shock, ”Goldstein said. “Now everyone is [waiting] to see what happens next – whether it’s just a temporary change or more persistent. “

A period of adjustment

The way inflation has played out in previous events may not reflect its behavior in the coronavirus crisis, which is “quite different” from the 2008-2009 financial crisis, Goldstein noted. “Right now there are big imbalances between supply and demand for various goods. On the one hand, you have pent-up demand for cars, travel and things like that. On the other hand, due to various frictions in the supply chain and in hiring, you see supply issues. And [those problems] drive up prices. On top of that, you have all the government and monetary incentives, which can push up some inflation. “

Goldstein has described the current times as “a period of adjustment” on several fronts, including the demand and supply of goods and the prices of goods, and the labor market. The last employment report for April showed a gain of 266,000 jobs, lower than expected. He noted that some policies put in place during the pandemic “keep people off going back to work”, such as direct cash transfers and expanded unemployment benefits. Other factors are also hampering the increase in employment: “We still do not have full in-person schooling in many places, which places constraints on parents and their working flexibility. “

Above all, uncertainty remains about the direction and pace of the pandemic. “Are we really out of the woods and able to move forward?” Goldstein asked. “This is all still hanging in the air, and you see it in various pieces of data like prices and unemployment which are extreme and surprising in many ways.”


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