Inflation May Already Have Peaked. Overreacting Brings Its Own Risks

Whether you are an “average” American, a central banker, a CEO or a parking attendant, inflation is now the primary economic concern for most Americans. Polling bears that out: for the first time in decades, a notable portion of Americans say inflation is the number one issue facing the country. Each new economic release points to higher inflation, including the most recent government report that showed prices up 8.3% year-over-year. News about high inflation then feeds general concerns about higher prices, and escalating costs of gasoline and groceries combined with rising interest rates making mortgages more expensive collectively fan the flames.

There is now a broad consensus that inflation is not only too high but that there’s no immediate end in sight. Hence the aggressive rhetoric coming from the Federal Reserve about raising the target for short-term interests more quickly and sharply, which led the bank to a 50bps rate increase in early May. And hence the panic in the Democratic Party (and glee in the Republican) that voters will hold Democrats accountable for rising prices in the fall midterms. But a consensus about future outcomes doesn’t mean certainty about future outcomes. It may be that elevated inflation is now a thing. But what if the consensus is, as is so often the case, wrong? What if those who last year said that inflation was, the words of the chair of the Fed Jerome Powell, “transitory,” were more right than wrong even though they underestimated how long transitory would last? What if the predisposition of so many for so many years to be on guard against inflation has also made them inflation paranoid?

The most vocal inflation hawk over the past year is former Treasury Secretary and former Obama economic czar Larry Summers. He warned the size of the federal COVID-19 aid bill in early 2021 combined with very low interest rates would trigger inflation, and he has been loudly critiquing the Fed for being “behind the curve” in its delayed willingness both to raise interest rates and to curtail its policy of buying bonds to bolster the markets. Now that inflation has been elevated for months, he has been doing the rhetorical version of victory laps and many have cited him as part of an overall argument that for the first time since the late 1970s, the inflation genie has been let out, with unpredictable and likely destructive consequences.

Until 2021, inflation had been the proverbial dog that didn’t bark, but that only solidified a view especially prevalent in the financial community that when inflation eventually did rear once again, it would do so with a vengeance. The thesis went like this: for decades, but especially since the financial crisis of 2008-2009, the price of money had been artificially kept low by global central banks with the result that while there was little measurable inflation of the goods people use (gas, food, furniture), there was lots of covert inflation in the prices of homes and stocks. What’s more, the efforts of central banks to keep markets liquid was simply delaying the inevitable.

That inevitable arrived in 2021 when the combined effects of a waning pandemic and trillions of dollars in government stimulus in the U.S. and around the world led to an explosion of pent-up consumer demand, which completely deluged global supply chains that weren’t staffed or prepared. Hence the shortage of semiconductors chips for automobiles, for instance, or the lack of enough glass bottles for all the booze people were buying, And then came the Russian invasion of Ukraine, which sent commodity and agricultural prices soaring. The Fed has kept rates low, and now we are in an inflation spiral.

That certainly describes the past year. That is not the same thing as describing the year (or years ahead). In the most recent report, the 8.3% number got the most attention, because that confirmed the current narrative of “inflation is out of control and the Fed is behind and the government has overspent.” But the month-over-month increases have been plateauing in recent months, except for energy costs which the Fed can’t do much about and has more to do with the disruptions stemming from the embargoes against Russia.

In short, the monthly pace of inflation is now much slower than the year-over-year rate and has shown signs of stabilizing. In addition, in the months ahead, the headline inflation numbers will start to reflect comparisons from mid-to-late 2021, when prices had begun to rise from their pandemic lull. That means that headline inflation (which measures year-over-year) will almost certainly moderate, even in the absence of whatever the Fed does to increase rates.

Inflation is an economic statistic, but it is also an intensely charged word and experience. The DNA of every central bank is to fight inflation. After all, the political crises and wars in the early to mid-20th century were all preceded by intense periods of price instability, with inflation in Weimar Germany seen as prime cause of the rise of Nazism. Even as the main challenge from about 2000 through 2021 was lower growth and deflation of the cost of goods grace the twined effects of globalization and technology, the fear of inflation always trumped the challenges of deflation in the minds of bankers and policymakers. Now, with real inflation for the first time in more than a generation, the dormant fears have been roused, and fear has a way of gripping not just our sense of the present but foreboding about the future.

That is not a sound recipe for policymaking. Nor is the “I told you so” mantras so prevalent now. We can expect political opponents seeking office to use inflation as a cudgel to hit those currently in power, but neither fear nor political opportunism nor reputation burnishing are good foundations for assessing where we are and where we are going.

The burst of inflation the past months makes sense in the context of lots of government spending, pent-up demand, global supply chains disrupted by the pandemic and by politics and then the commodity shock of the Russian invasion of Ukraine. All of those are indeed “transitory,” even if the length of transitory is longer than a brief few months. But that is a far cry from chronic inflation that now requires draconian action on the part of central banks. Some of that goods-and-services inflation has been a by-product of rising wages for the lower income tiers, which is unquestionably a good thing. It would be a travesty if in trying to dampen inflation, policymakers manage to increase unemployment and lower wages in a “we had the burn the village in order to save it” approach. And of course, the deflationary effects of technology haven’t gone away, even as they are currently less potent than the forces above.

At a time when the consensus says fight inflation now at all costs, it’s vital to untangle the web of fear and assumptions about the future that are combining to dictate a draconian policy response that may be unnecessary. The past few years, framed by an unprecedented global response to a pandemic, have hardly been normal. Perhaps we should wait a bit longer before assuming that we know how this plays out. If we don’t, we may be poised to inflict more harm than necessary to fight a problem that has already peaked.