Year-on-year inflation rates have reached their greatest levels in over three decades as the global economy recovers from the COVID-19 epidemic. Is this higher inflation just a blip on the radar, or is it here to stay? Patricia Sanchez Juanino, Corrado Macchiarelli, and Barry Naisbitt explore US inflation possibilities for the next 18 months to answer these questions. They believe that inflation will peak at 5% in the coming months and then remain close to 4% in the near term: this may happen if, for example, inflation expectations continue to rise.
The 12-month CPI inflation rate in the United States reached its highest level since 1990 in October 2021, at 6.2 percent year-on-year. Pent-up demand and rising energy prices have been primary drivers of the increase, but supply chain constraints and spikes in other commodity prices have also played a role. A crucial policy question is whether the current rise in US inflation is only temporary, as it was in 2008, or if it signals the start of a longer era of inflation above the 2% objective, like it did in the 1970s and early 1980s.
The Federal Reserve has revised up its annual inflation predictions for both this year and next year as the year has progressed. The September median prediction for year-on-year PCE (household consumption) inflation in the fourth quarter increased to 4.2 percent this year and 2.2 percent next year. Both forecasts are higher than those issued in March: 2.4 percent in 2021 and 2% in 2022. Despite the fact that predictions have risen, Federal Reserve policymakers still expect inflation to decline considerably next year. The Federal Open Markets Committee (the group that decides on the right monetary policy stance) stated in November that it will cut its monthly purchases of Treasury securities and mortgage-backed securities, a policy known as tapering. However, it continued to emphasize that the spike in inflation, as reflected in its inflation estimates, was primarily transitory.
While we anticipate a reduction in inflationary pressure, we are concerned that the reduction will be insufficient. Annual US PCE inflation would grow from 1.2 percent in the fourth quarter of last year to 5.1 percent this year, then decline to 2.3 percent in the fourth quarter of 2022, according to the National Institute’s Autumn 2021 Global Economic Outlook. However, we believe that the risks are skewed to the upside, and that if they materialize, the Federal Reserve will be forced to tighten monetary policy sooner than it appears to be planning.
Inflation scenarios for 2022-23
To demonstrate the dangers, we employ Huw Dixon’s technique from Cardiff University, which allows us to make stylized assumptions about future monthly price fluctuations in order to generate various annual inflation routes over the next 18 months. Three scenarios are examined (rather than forecasts).
In the best-case scenario, monthly inflation reduces steadily until it reaches its average level for the five years prior to the pandemic in June of the following year, and then stays there. After that, the monthly price changes are converted into year-over-year inflation. On this measure, annual PCE inflation would decline to 2.1 percent in the fourth quarter of next year, roughly in line with the Federal Reserve’s consensus forecast.
We look at two other scenarios that are much less reassuring. We assume that the extent of monthly price increases decreases, but not as quickly or as far as before the pandemic, so that it reaches twice the pre-pandemic period average in June. In this instance, annual PCE inflation in the fourth quarter of next year would be 3.2 percent.
Finally, if monthly PCE inflation stays at its current level (0.3 percent) for the rest of the year, annual inflation in the fourth quarter of next year will be 3.9 percent. Figure 1 depicts the year-on-year inflation projected lines for several scenarios.
Figure 1: Year-over-year PCE inflation projections based on stylized monthly assumptions (percent)
The most intriguing aspect of these scenarios is that they all hint to annual inflation being near 5% in the next months. Figure 1 shows that, despite monthly inflation returning to the 2015-2019 average by next June, year-on-year inflation continues to rise over the following few months, reaching 5%, as lower monthly rises in 2020 are replaced by greater monthly increases this year. In the best-case scenario, annual inflation returns to 2% by the end of next year. If monthly inflation stays at 0.3 percent, year-over-year inflation will remain persistently close to 4%.
These are simply projections based on stylized assumptions, not forecasts or a deep examination of the underlying reasons influencing recent and future monthly price fluctuations. They are broadly consistent with the idea that annual inflation risks will remain strong through 2022, even if recent price hikes owing to supply chain disconnections fade away over time. If policies do not prevent inflation expectations from rising, the situation may worsen.
With its new mandate and a strong focus on maximum employment, the Federal Reserve expects a temporary (or, in today’s lingo, transitory) overshoot of inflation above its target, especially when it follows a long period of undershooting. If inflation expectations become skewed and wage-push inflation forces increase, a temporary overshoot could turn into a long-term one.
Higher inflation may be here to stay
According to our forecasts, the current rate of inflation could return to its target rate by the end of 2022. However, it appears that inflation will continue to exceed the objective for some years. If inflation reaches 5%, the Federal Reserve will need to significantly up its policy messaging, arguing that the spike is just temporary and convincing families, businesses, and financial markets that monthly inflation will soon revert to lower levels. If the current supply-chain disruption and global energy price increases end, its arguments will be strengthened.
The Federal Reserve has yet to clarify the timeframe of ending quantitative easing, reversing it, and subsequently raising policy interest rates. For example, an unexpected policy reversal to protect central bank credibility could cause a quick financial market slump and public sector balance sheet imbalances. How central banks respond to increasing inflation, through a mix of terminating quantitative easing and raising policy rates, will determine bond prices.
Inflation expectations are rising, and the Federal Reserve needs to create contingency plans for its actions if a 5% inflation rate appears to be embedded. If it lifts its inflation predictions again after its December meeting, as we expect, such contingency measures may be required sooner rather than later. Given the uncertainty about the duration of higher inflation, wages, and an employment rate that remains below pre-pandemic levels, we believe the Federal Reserve will be cautious in tightening policy, especially because it will have to choose between stabilizing below-target employment and stabilizing above-target inflation. Moving too far, too fast, risks squandering the best chance it has to avoid near-deflationary traps with interest rates at their lowest levels. They are likely to pay the price if it is a time of significantly above-target inflation.
- “US inflation peaking soon?” in National Institute of Economic and Social Research (Box A), Global Economic Outlook, Series B., No. 4, Autumn, pp. 24-30, is the basis for this article. ‘Global Economic Outlook’, Series B, No. 4, Autumn, NIESR (2021).
What will be the rate of inflation in 2022?
According to a Bloomberg survey of experts, the average annual CPI is expected to grow 5.1 percent in 2022, up from 4.7 percent last year.
What is the highest rate of inflation ever?
Between 1914 and 2022, the United States’ inflation rate averaged 3.25 percent, with a high of 23.70 percent in June 1920 and a low of -15.80 percent in June 1921.
Is inflation expected to worsen in 2022?
If inflation stays at current levels, it will be determined by the path of the epidemic in the United States and overseas, the amount of further economic support (if any) provided by the government and the Federal Reserve, and how people evaluate future inflation prospects.
The cost and availability of inputs the stuff that businesses need to make their products and services is a major factor.
The lack of semiconductor chips, an important ingredient, has pushed up prices in the auto industry, much as rising lumber prices have pushed up construction expenses. Oil, another important input, has also been growing in price. However, for these inputs to have a long-term impact on inflation, prices would have to continue rising at the current rate.
As an economist who has spent decades analyzing macroeconomic events, I believe that this is unlikely to occur. For starters, oil prices have leveled out. For instance, while transportation costs are rising, they are not increasing as quickly as they have in the past.
As a result, inflation is expected to moderate in 2022, albeit it will remain higher than it was prior to the pandemic. The Wall Street Journal polled economists in early January, and they predicted that inflation will be around 3% in the coming year.
However, supply interruptions will continue to buffet the US (and the global economy) as long as surprises occur, such as China shutting down substantial sectors of its economy in pursuit of its COVID zero-tolerance policy or armed conflicts affecting oil supply.
We can’t blame any single institution or political party for inflation because there are so many contributing factors. Individuals and businesses were able to continue buying products and services as a result of the $4 trillion federal government spending during the Trump presidency, which helped to keep prices stable. At the same time, the Federal Reserve’s commitment to low interest rates and emergency financing protected the economy from collapsing, which would have resulted in even more precipitous price drops.
The $1.9 trillion American Rescue Plan passed under Biden’s presidency adds to price pressures, although not nearly as much as energy price hikes, specific shortages, and labor supply decreases. The latter two have more to do with the pandemic than with specific measures.
Some claim that the government’s generous and increased unemployment insurance benefits restricted labor supply, causing businesses to bid up salaries and pass them on to consumers. However, there is no proof that this was the case, and in any case, those advantages have now expired and can no longer be blamed for ongoing inflation.
It’s also worth remembering that inflation is likely a necessary side effect of economic aid, which has helped keep Americans out of destitution and businesses afloat during a period of unprecedented hardship.
Inflation would have been lower if the economic recovery packages had not offered financial assistance to both workers and businesses, and if the Federal Reserve had not lowered interest rates and purchased US government debt. However, those decreased rates would have come at the expense of a slew of bankruptcies, increased unemployment, and severe economic suffering for families.
Has the United States ever experienced hyperinflation?
The trend of inflation in the rest of the world has been quite diverse, as seen in Figure 2, which illustrates inflation rates over the last several decades. Inflation rates were relatively high in many industrialized countries, not only the United States, in the 1970s. In 1975, for example, Japan’s inflation rate was over 8%, while the United Kingdom’s inflation rate was around 25%. Inflation rates in the United States and Europe fell in the 1980s and have mainly been stable since then.
In the 1970s, countries with tightly controlled economies, such as the Soviet Union and China, had historically low measured inflation rates because price increases were prohibited by law, except in circumstances where the government regarded a price increase to be due to quality improvements. These countries, on the other hand, were plagued by constant shortages of products, as prohibiting price increases works as a price limit, resulting in a situation in which demand much outnumbers supply. Although the statistics for these economies should be viewed as slightly shakier, Russia and China suffered outbursts of inflation as they transitioned toward more market-oriented economies. For much of the 1980s and early 1990s, China’s inflation rate was around 10% per year, however it has since declined. In the early 1990s, Russia suffered hyperinflationa period of extremely high inflationover 2,500 percent a year, yet by 2006, Russia’s consumer price inflation had dropped to 10% per year, as seen in Figure 3. The only time the United States came close to hyperinflation was in the Confederate states during the Civil War, from 1860 to 1865.
During the 1980s and early 1990s, many Latin American countries experienced rampant hyperinflation, with annual inflation rates typically exceeding 100%. In 1990, for example, inflation in both Brazil and Argentina surpassed 2000 percent. In the 1990s, several African countries had exceptionally high inflation rates, sometimes bordering on hyperinflation. In 1995, Nigeria, Africa’s most populous country, experienced a 75 percent inflation rate.
In most countries, the problem of inflation appeared to have subsided in the early 2000s, at least when compared to the worst periods of prior decades. As we mentioned in an earlier Bring it Home feature, the world’s worst example of hyperinflation in recent years was in Zimbabwe, where the government was issuing bills with a face value of $100 trillion (in Zimbabwean dollars) at one pointthat is, the bills had $100,000,000,000,000 written on the front but were nearly worthless. In many nations, double-digit, triple-digit, and even quadruple-digit inflation are still fresh in people’s minds.
What was Germany’s strategy for overcoming hyperinflation?
The early 1920s hyperinflation in the Weimar Republic was not the first or even the most severe case of inflation in history (the Hungarian peng and Zimbabwean dollar, for example, were both more inflated). It has, nevertheless, been the focus of the most in-depth economic examination and debate. Many of the dramatic and unusual economic behaviors now associated with hyperinflation were first documented systematically during the hyperinflation, including exponential increases in prices and interest rates, currency redenomination, consumer flight from cash to hard assets, and the rapid expansion of industries that produced those assets.
Chartalism and the German Historical School influenced German monetary economics at the time, which influenced how the hyperinflation was evaluated.
The situation was stated by John Maynard Keynes in The Economic Consequences of Peace: “Inflationary pressures in Europe’s monetary systems have reached unprecedented levels. The different belligerent governments, unwilling, frightened, or short-sighted enough to get the resources they required through loans or levies, have printed notes to make up the difference.”
During this time, French and British economists began to claim that Germany purposefully damaged its economy in order to avoid paying war reparations, but both governments disagreed on how to address the problem. The French declared that Germany should continue to pay reparations, but the British requested a moratorium to allow for financial restoration.
Between 1920 and 1923, reparations accounted for approximately a third of the German deficit, and the German government recognized them as one of the main causes of hyperinflation. Bankers and speculators were also mentioned as contributing factors (particularly foreign). By November 1923, hyperinflation had reached its peak, but it was halted when a new currency (the Rentenmark) was created. Banks “handed the marks over to junk dealers by the ton” to be recycled as paper to make space for the new currency.
Firms responded to the crisis by concentrating on the aspects of their information systems that they determined were critical to their ability to continue operations. The first focus was on altering sales and procurement arrangements, financial reporting changes, and the use of more nonmonetary data in internal reporting. Human resources were redeployed to the most vital company tasks, particularly those concerned in labor remuneration, as inflation continued to rise. Some aspects of corporate accounting systems appear to have fallen into disrepair, although there was also innovation.
Why is inflation in 2022 so high?
The higher-than-average economic inflation that began in early 2021 over much of the world is known as the 20212022 inflation spike. The worldwide supply chain problem triggered by the COVID-19 pandemic in 2021, as well as bad fiscal policies in several nations and unanticipated demand for particular items, have all been blamed. As a result, many countries are seeing their highest inflation rates in decades.
In the United States, where is the highest inflation rate?
While inflation is wreaking havoc on people’s wallets across the country, inhabitants in many areas face rates that are greater than the national average.
Inflation is above 7.5 percent in the Midwest, South, and West, according to Labor Department data. Surprisingly, inflation in the Northeast is running at a significantly lower rate.
In addition, the Labor Department keeps track of inflation in large metro regions. The Tampa Bay region has the highest inflation rate in the country, according to current data.
Is the United States printing too much money?
It’s possible that some individuals of the general population believe this. The majority of authority, on the other hand, answer “No.” Asher Rogovy, an economist, debunks the common online claim that the United States is printing too much money, resulting in hyperinflation.
What happens if inflation rises too quickly?
If inflation continues to rise over an extended period of time, economists refer to this as hyperinflation. Expectations that prices will continue to rise fuel inflation, which lowers the real worth of each dollar in your wallet.
Spiraling prices can lead to a currency’s value collapsing in the most extreme instances imagine Zimbabwe in the late 2000s. People will want to spend any money they have as soon as possible, fearing that prices may rise, even if only temporarily.
Although the United States is far from this situation, central banks such as the Federal Reserve want to prevent it at all costs, so they normally intervene to attempt to curb inflation before it spirals out of control.
The issue is that the primary means of doing so is by rising interest rates, which slows the economy. If the Fed is compelled to raise interest rates too quickly, it might trigger a recession and increase unemployment, as happened in the United States in the early 1980s, when inflation was at its peak. Then-Fed head Paul Volcker was successful in bringing inflation down from a high of over 14% in 1980, but at the expense of double-digit unemployment rates.
Americans aren’t experiencing inflation anywhere near that level yet, but Jerome Powell, the Fed’s current chairman, is almost likely thinking about how to keep the country from getting there.
The Conversation has given permission to reprint this article under a Creative Commons license. Read the full article here.
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Prices for used cars and trucks are up 31% year over year. David Zalubowski/AP Photo