This leaves the Fed in a pickle: Interest rate hikes won’t do much except reduce demand, producing stagflation
https://asiatimes.com/-by David P. Goldman
US inflation keeps spiralling upward, recently touching a 40-year high. Image: Screengrab / iStock
US stocks took a nasty turn downward after the Bureau of Labor Statistics announced a higher-than-expected 7.5% jump in consumer prices over the last 12 months, the worst inflation in forty years. The month’s gain of 0.6% for the Consumer Price Index also translates into an annual rate of 7.5%.
Most worrying about the inflation report was the dog that didn’t bark, namely shelter inflation. Although the shelter component of the Consumer Price Index did rise in January, it showed an annualized rate of just 3.7%, much lower than the nearly 20% price gains for home prices and 13% hikes in residential rents during the past year.
Monthly changes in the Zillow national rent index predict changes in the CPI rent component with lags of up to eight months, as we noted last August 27. But rents didn’t drive the January jump. Instead, price increases were distributed across the board.
Average real weekly earnings have fallen by 3.1% over the past twelve months, the worst year-on-year change since the series began in 2007. The fall in inflation-adjusted weekly pay in January was more severe than during the 2008 financial crisis. In a tight labor market, that sets in motion employee demand for pay increases. Those increases in turn raise employers’ costs and motivate further price increases.
Some analysts noted with alarm that the monthly increase in consumer prices was 0.8% without seasonal adjustment, rather than the 0.6% seasonally-adjusted number reported by the BLS. Annualized, that’s 10% rather than 7% inflation. In this case, I think the BLS’s seasonal adjustment is justified. I reproduced the BLS’s seasonal adjustment using the Eviews econometric platform. This is a sophisticated procedure that takes into account the moving trend of inflation. The seasonal adjustment includes a markedly increasing trend-cycle component, shown in the chart below.
The problem, as noted, isn’t seasonal adjustment – it’s that the BLS estimate of rent inflation bears no relationship to the real-world observations of private organizations like Zillow or Apartmentlist.com. This has to come out in the wash eventually, and the likelihood is that inflation will continue to raise at painfully high levels for the next year.
That leaves the Federal Reserve in a pickle. The Fed can suppress inflation by raising interest rates only when credit expansion is a driver of inflation. When investors think that real assets will appreciate and money will depreciate, they borrow in the expectation that the real cost of debt service will fall, and buy assets that they expect to appreciate.
That was the case in 1979, when Paul Volcker pushed short-term rates close to 20%. As the chart shows, bank lending had risen by 40% in the two years prior to Volcker’s shock. It isn’t true today. Bank credit to businesses in the past two years is dead flat. Banks have been buying government bonds rather than lending to businesses.
Today’s inflation is the result of $6 trillion in government subsidies to income in an economy that can’t meet the additional demand. A couple of percentage points worth of Fed interest rate hikes won’t do much except to reduce demand – that is, produce stagflation.