Cyclical Inflation Is Not "Transitory"
Federal Reserve Chairman Jerome Powell has recently stated that a rebound in inflation will prove to be "transitory" and not persistent. Mr. Powell is partially correct. Part of the rebound in inflation in 2021 will reflect the removal of price discounts during the steep drop in the economy in 2020. But the more significant and more persistent part of an uptick in inflation will reflect the growth dynamics and fiscal and monetary policies.
Cyclical upswings in inflation tend to lag the economic growth cycle as the downturn's disinflation forces still dominate price patterns. But the lags are uneven, with some short and others long. Transition to the cyclical uptick in inflation depends on two things: the growth rebound's speed and the stimulus force of fiscal and monetary policies.
In 2021, consensus estimates show that economic growth could hit 7%, the fastest annual growth rate since 1984 and the second-fastest yearly performance in the post-war period. Part of the growth rebound is the recovery from the steep fall in 2020, but the bulk comes from unprecedented fiscal expansion and monetary accommodation.
The stimulus package of $1.9 trillion passed by Congress is the most significant increase in federal spending since the 1950s. Directly and indirectly, the federal stimulus will help power fast growth in 2021 and into 2022. And the Biden Administration is contemplating an additional spending package amounting to $3 trillion for infrastructure that will be disbursed and spent over several years. Never before has the US economy been hit with so much fiscal stimulus and a monetary policy working in unison.
Transitory inflation is short-lived, with no spillover effect on general prices. An example of transitory inflation is the spike in Texas's energy prices following the severe winter storm that impacted the power grid.
Cyclical inflation, however, can become persistent, especially when there is an undercurrent of inflation reflecting consumer expectations and policymakers continue to misread the economy and price dynamics.
House price inflation, which policymakers overlook since it's not in reported inflation, has become persistent. According to the FHFA house price index, house prices have recorded annual increases of 5% or more for the last eight years. House price increases of that scale and length have only occurred twice before during the post-war period.
Expectations for house prices are important as they reflect people's attitudes towards economic conditions, access to credit, interest rates, or things that matter to monetary policy. A policy that continues to feed high house price expectations can also fuel more general inflation, especially when the federal government finances so much spending.
The cyclical inflation record of the last decades has probably influenced Mr.Powell's attitude towards inflation. That would be a mistake. The previous cycle's inflation trends should have almost no carryover effect. That's because this economic growth cycle is unique in that it has so many growth engines---aggressive federal spending program, record wealth, easy credit conditions, and unprecedented pent-up demand in a wide range of consumer services---along with extraordinary monetary accommodation.
One year from now, the only thing that will be "transitory" of the inflation cycle is its characterization.