Shifting away from ‘transient’ inflation

On Tuesday, US Senator Pat Toomey addressed the British economist John Maynard Keynes’s quote in the mid-20th century that “we are all dead in the long run”. Asked by Federal Reserve Chairman Jay Powell about the current bout of above-target inflation, Tommy said, “I know you think this is fleeting. But everything is fleeting. Life is temporary.”

Powell said wisely He will now give up the word, while acknowledging that describing high inflation as “temporary” causes a lot of confusion and clarity. The phrase was originally introduced as “transient” at the end of 2020 as Powell eyed inflationary pressures next year. It was aimed at understanding the idea that what the central bank should consider is neither a temporary rise in prices nor “core effects” from comparisons to the previous year but the bank’s ability to keep inflation sustainable on target. In Powell’s own words, the price increases “will not last indefinitely.”

Critics of the Fed’s monetary generosity, as well as its change of focus to consider “average inflation”, took advantage of Powell’s continued use of the word to suggest that the head of the central bank had taken his eye off the ball. In fact, Tommy also asked at a Senate Committee on Banking, Housing, and Urban Affairs meeting, “How long should inflation exceed your target before the Fed decides it might not be temporary?” The US central bank has repeatedly been forced to revise its price growth forecasts and acknowledge that the pressures are broader than originally expected.

Discussions about the exact meaning of the term were unhelpful, as was the division of economic commentators into a “transitional team” and a “permanent team”. Stopping using the phrase will remove one source of distraction and one unnecessary source of confusion. Aside from improving central bank communications, Powell’s position has also been just shifted a little. While he indicated that the Fed may offer to reduce its asset purchases for a few months, he still expects to ease inflationary pressures.

Powell will probably prove that inflation will go away. The sudden rise in natural gas prices may not be reversed, but it almost certainly will not be repeated. Nor will the staggering jump in used car prices that was a major driver of inflation. In fact, while the Paris-based Rich Country Research Center, The Organization for Economic Co-operation and Development has revised its forecast for US inflation For 2022 on Wednesday – to 4.4 per cent from 3.1 per cent – that still means inflation will spend most of next year below the current rate of 6.2 per cent.

What matters to the central bank is which part may not disappear. Over-target inflation may become self-sustaining if it results in firms and workers anticipating price increases and incorporating them into decision-making. Powell was right to say on Tuesday that this is an increased “threat”. Accelerating so-called quantitative easing by a few months is a reasonable response.

The new alternative Omicron is a potential spoiler. Not only is it still unclear whether vaccines are still effective against it, but its amplifying effect is as well. The Organization for Economic Co-operation and Development has indicated that it is likely to exacerbate the supply chain problems – as well as shifts in spending from services to goods – that have caused shortages. On the other hand, few travel or hospitality companies are likely to feel as if they have significant pricing power, even if the growing fear of contagion is contributing to a labor shortage. Powell may have dismissed the word “temporary” but the inflation debate remains.

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