United States Economic Forecast

When is a rise in prices not inflation?

Each month yields a stream of official economic data releases. For the most part, newspapers bury stories about this data somewhere deep inside, while economists and financial market traders pour over it for nuggets of information about how the economy is developing. But the November 10 release for the October 2021 Consumer Price Index (CPI) was different. The highest quality US newspapers made the CPI the top story for the day, with generous front-page coverage as well as pages of supporting commentary in the middle of the front section. It’s not like it was a “slow news day.” It was the culmination of an increasing media focus on inflation, which is at odds with the consensus among economic forecasters. Many economists agree with Fed officials and staff that the current price increases are “transitory,” even if Fed Chair Jerome Powell has “retired the term.”¹ Surveys of economists, such as the Wall Street Journal Forecasters’ survey, show that most forecasters do, in fact, expect inflation to moderate by the second half of 2022. Why do economists remain so optimistic?

Some prices are rising

The pandemic changed the global economy very quickly. Businesses have scrambled to keep up, first as activity plunged in the spring of 2020, then as recovery occurred faster than expected … but with large changes in the structure of demand. In the United States, nonresidential construction remains 20% below the prepandemic level, while consumer purchases of durable goods soared to almost 30% above the prepandemic level before starting to decline in the second half of this year. Faced with such large swings in demand, it’s not surprising that businesses have had trouble calibrating their operations and, in many cases, finding key supplies. The broad shift from services to goods has been particularly difficult, since it’s often much harder to ramp up goods production quickly than it is to ramp up production in services industries.

The result is a series of shifts in prices. Some of the most dramatic price rises have been for commodities such as crude oil (up 67% from the beginning of the year through October), copper (up 26%), or chickens (up 25%). But such commodity price rises happen on occasion, and don’t lead to systemic inflation. They usually represent one-time changes in prices, reflecting the changing scarcity of different goods and services. And scarcity can change over time. Airline fares, for example, rose dramatically earlier in the year, but have since fallen back (and are still over 20% below the prepandemic level).

This makes the October rise in consumer prices look a lot less scary. In fact, October’s rise came after three months in which the core inflation rate was well within “reasonable” bounds. All economic data is volatile, and the one month of higher inflation could well fade away.

Keep watch, but keep calm

There are some worrying signs. First, the rise in shelter costs—the largest component in the CPI—has remained moderate even as house prices have grown quickly. There is some evidence that the methodology for calculating shelter prices causes house price changes to be reflected in the CPI with a lag of a year or so. If that’s the case, we may start seeing shelter prices accelerate, keeping measured inflation high.² Second, an increasing share of the components of the CPI are seeing accelerating price rises, which suggests the possibility that the price hikes are becoming embedded in business dealings—an important element in translating one-time price hikes into systemic inflation. Third, some wages have begun to rise more quickly than they did pre-pandemic. While significant wage rises are still limited to those industries and workers that were most affected by the pandemic (in particular, leisure and hospitality), overall employment costs do seem to be accelerating. That’s the most worrisome signal; if higher prices for select commodities and goods become embedded into everybody’s views about future prices, inflation could become widespread. That could certainly require a policy response.

For now, the evidence that inflation could become systemic is not very strong. Keep in mind that in the 1970s, it took years (and a shockingly large rise in oil prices) for inflation to become embedded in the expectations of households and businesses. So far, there aren’t any signs that long-run expectations of inflation are rising. This is a good indication that it would take many months of continued reports such as October’s CPI release before inflation becomes a serious long-term threat to economic stability.

Deloitte’s new forecast includes a scenario in which inflation becomes a significant problem. We expect that this scenario has a relatively low probability, however. The flurry of concern about inflation based on the October CPI release says more about the difficulty the news media faces in reporting on economic events than it does for the potential of actual inflation breaking out.

Inflation is better than the alternative

One further key point about the current inflation problem: It is the result of the pandemic, but also the highly successful attempts in the developed world to preserve incomes for the relatively low-paid workers, who were most at risk from the pandemic (both economically and medically). Those higher incomes allowed demand to pick up to levels that created some of the shortages that now plague the economy. But that’s a much better economic outcome than the alternative: letting the pandemic create widespread misery among workers and families in pandemic-sensitive industries. If inflation is the cost of that prevention, it’s a price that was well worth paying.