We are seeing an explosion in prices around the world, and the Fed is rather pleased about it. Well, it is not totally pleased but satisfied to a point.
It has been said for a decade that the Fed has wanted to see some inflation creep into the economy, though it has been nascent for years. But isn't it odd that the chief inflation fighter (the Fed), with a track record of 42 years and growing, would want to see rising inflation? It certainly makes one scratch their head.
Let's peel back the onion a bit so we can figure this out together. After the Great Financial Crisis in 2008-09 companies were forced to lower prices as demand for end products was very weak due to substantial job losses and sharp moves down in the stock market. Without getting into too much detail, prices started spiraling lower at a swift pace, hence the Fed saw the need to reverse this trend by purchasing bonds (quantitative easing, or QE) and keeping rates as low as possible.
In previous times and other economies this trick worked nicely and it seemed this time around it would work, too, as the Fed had an open-ended timetable. But even Fed Chairman Ben Bernanke wasn't able to ignite inflation much with three different QE programs. The 2% inflation goal the Fed set in 2011 was elusive.
In 2020 the pandemic forced the Fed to make some quick maneuvers in order to keep the economy from undergoing a spectacular decline. Chairman Jerome Powell used all the tools at his disposal to head off the undesired deflation that occurred just 10 years earlier. It seems to have worked this time. Supply chain issues, strong end demand, re-pricing of goods and sticky price increases are all happening today.
This is why it should not be a shock to see large increases in the Consumer Price Index (CPI) and other measures of inflation. The question today is how much longer will the Fed accept strong inflationary trends? Inflation expectations are still rather contained, with FRED data putting the 10-year inflation breakeven rate today at just 2.27%.
But 2.2% is not the rate of inflation today; rather, it is much higher. How much longer can the consumer's buying power be sapped by rising prices? Also, wage increases are not even close to keeping up with price inflation, so fewer dollars are coming after goods. There is a huge disconnect that credit seems to be filling in the gaps. If demand ever falls off a cliff, prices again will come tumbling to earth.
We all are feeling the effect of higher prices in all aspects of our lives: groceries, travel, vacation, gasoline, shopping. It doesn't feel good when the cost of a used vehicle is up 30% from a few short months ago for no apparent reason.
It's a difficult challenge for the Fed to determine the right timing of tighter policy. The pandemic is not getting better and we are not seeing the robust job gains on a consistent basis the Fed is seeking. That may change soon, hence policy is probably closer to a moderate change than none at all.