Calm down! Recent inflation reports have caused alarm and, frankly, overreaction. The overall Consumer Price Index increased again in May, bringing the rate over the last 12 months to 5.0%. It was the largest 12-month increase since a 5.4% rise observed in August 2008, during the midst of the Great Recession. The index for all items less food and energy rose 3.8%, the largest annualized increase since June 1992.
There are two primary reasons (and several smaller ones) for the current situation. First, the 12-month timeframe puts us back to last spring, when things were largely shut down. This massive pandemic disruption caused prices to drop for a variety of goods and services. In other words, the denominator is unusually low. For example, airline fares were up 10.2% in April and 7.0% in May. When few could safely fly a year ago, fares naturally dropped; as things reopen, they’re rising. No surprise.
Similarly, energy costs are up sharply (28.5% over the year). When the world shut down last year, demand for fuels was basically nonexistent and prices plummeted, with oil prices even being briefly negative. Summer is unleashing people who have been isolated to drive and fly; thus, prices are escalating. As things open up, with policy providing both mounds of stimulus cash and cheap credit, spending is soaring.
The other primary reason for the current inflation is the supply chain. With shuttering of manufacturing facilities and transportation interruptions during the pandemic and other logistical challenges (such as ships blocking canals), there are shortages in numerous items. For example, the semiconductor chips that run everything from cars to household appliances are in extremely short supply. Consequently, production of new automobiles has been curtailed. The index for used cars and trucks spiked 7.3% in May, accounting for about one-third of the aggregate increase. The difficulties in getting people back to work add to this conundrum.
In short, demand is surging and supply is lagging, both of which are residual effects of the global meltdown. If sustained, the current inflation level would cause notable harm, eroding purchasing power and decreasing standards of living. That’s unlikely to happen. The primary reasons for the pattern we’re seeing are transitory. Demand will normalize and supply chain issues will be resolved. That’s what markets do. In fact, the 10-year Treasury bond yield, a relatively reliable predictor of long-term inflation, is consistently hovering well below 2%.
The current situation certainly calls for vigilance, and the Federal Reserve is appropriately paying close attention. However, it’s no reason to panic. The next few months will likely see big numbers, but things should then settle to more typical patterns. Relax. It’s summer. Go to the beach. Stay safe!