In spite of the somewhat positive spin that the media is trying to put on the recently released inflation rate data, the .8% gain in the Consumer Price Index (CPI) for April is very worrisome. Especially considering it follows a CPI monthly gain of .3% in January, .4% in February and .6% in March. That means inflation for 2021 is running at about 6% on an annual basis.
The monthly CPI number shows the price increase from the prior month. In other words, prices were .8% higher in April than they were in March. If the CPI increased at .8% per month for each of the next twelve months, the annual inflation rate would exceed 9%. Inflation is a problem right now. And it will get worse in the future.
To make the problem seem less devasting, the media measures the CPI for the last twelve months. Since the economy was fully or partially shut down since mid-March 2020 the CPI was running at a very low rate. Monthly CPI increases for most of 2020 were in the .2% range.
That means if we measure price increases from April 2020 to April 2021, the increase is only 4.2%. While that is twice the Federal Reserve (FED) target and it’s the fastest twelve-month rate since 2008, it doesn’t seem as bad as the 6% inflation rate that we have seen since the beginning of 2021.
The FED continues to say that the inflation spike is temporary and inflation will go back down once the economy fully re-opens The means the FED will continue its current policies which result in a massive increase in the money supply and interest rates near zero.
The FED claims the inflation spike is due to supply chain disruptions which are temporary. Lumber and other commodity prices have soared in the last few months, but the FED believes these prices will fall once the economy fully re-opens.
The FED is correct that increasing the supply of commodities will put downward pressure on prices, but the inflation we are experiencing is the result of more than just commodity price increases, that spiked due to supply chain disruptions.
The federal government has already overstimulated the economy. In fiscal 2020 and fiscal 2021, the federal government will have spent as much as $7 trillion more than was received in revenue. These unprecedented deficits have put massive amounts of new demand into the economy. Prior to COVID, the federal government spent about $4.5 trillion annually, so a massive $7 trillion deficit will put way too much demand into the economy.
While many commodity prices could soften as the economy fully re-opens, energy prices will continue to rise. Increased worldwide demand coupled with supply restriction in the US from the Biden administration’s energy policies, will fuel higher energy prices. These ripple through the economy putting upward price pressure on almost all goods.
The FED is continuing to purchase $80 to $120 billion in government bonds monthly. They do this simply by electronically printing more money which increases the money supply. In a high-growth economy, which is what we have seen since last May, this rapid money supply growth will be purely inflationary.
It is important that the FED act now to minimize inflation. They would do that by starting to gradually raise interest rates and significantly reduce their monthly bond purchases. In 2017, the FED began to follow this policy when they increased interest rates eight times from the beginning of 2017 to the end of 2018. While some argued this action slowed economic growth, it did result in very low inflation.
On both fiscal and monetary policy, the data indicates the economy is rapidly recovering so that expansive policies are no longer needed and may well be counter-productive. No more stimulus spending is needed. Spending additional trillions, which would further increase the deficit, will only result in more inflation.
No more expansive monetary policy is needed either. Continued increases in the money supply and the holding down of interest rates, will add to excess demand that will be purely inflationary.
It has been four decades since the US experienced a severe inflation problem. Since then the FED has always set low inflation as its primary policy goal and inflation has been tame. Now is the time for the FED to act to head off inflation. Waiting longer will only serve to make the inflation cure that much more painful.