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Inflation Blues


There are disadvantages to remembering the 1970’s, which was a time of high inflation.  The disadvantage is that you see a return to high inflation behind every bush.  Currently, the stock market is over-reacting to the fear of higher inflation, which is tougher on lower-income people, not that the stock market cares about lower income people, but the market knows high inflation will bring higher interest rates – possibly crippling higher interest rates if the Fed gets “tough on inflation” . . . like it did in 1980.

If you’re a Monetarist, you believe that inflation results when the money supply grows faster than the economy, which it has for the past year, when the Fed was pumping up massive liquidity as the economy collapsed.

If you’re a Keynesian, you believe that inflation results when demand exceeds supply.  Demand is surging after being constrained by the pandemic, and supply is chaotic right now with supply chain problems.  (If you’re a Republican, you believe Democrat spending produces excess demand.  If you’re a Democrat, you believe Republican tax cuts produce excess demand.)

If you’re Jerry Powell, head of the Federal Reserve, you’re not terribly surprised by today’s STRONG CPI estimate of 4.2%, much stronger than the expected 3.6%.  He’s been expecting inflation to surge, but it will be transitory.  Think of a tsunami of water crashing over you.  It rushes in and then drains out.  The economy has experienced a tsunami of liquidity over the past year, causing a temporary surge in inflation.

I think that’s reasonable, with one big caveat — expectations.  Once people expect higher prices they will start pricing their own goods & services higher.  They will not search as hard for lower prices, as they expect to pay more.  The expectation will actually produce the inflation.  The Fed always mentions whether inflationary expectations are “well-anchored” or not.  If they see the anchor slipping, expect faster interest rate increases.

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