Will inflation prove a bump in the road of higher economic growth, or will it transform into a monster that will run out of control, eventually taking rates up with it?
Federal Reserve Chairman Jerome Powell is saying publicly he views rising prices as "transitory," but others aren't so sure -- as costs of raw materials like lumber and steel rise, the value of used cars climb, computer chips see a supply squeeze, restaurants reopen, and oil appears to make a comeback.
"These things are all quite distorted by the pandemic and by the reopening following the pandemic," Capital Economics' economist Jennifer McKeown told TheStreet during a recent phone call.
TheStreet spoke about inflation with McKeown, who is the head of the Global Economics Service at Capital Economics, and who had previously worked for five years at the Bank of England.
Here the London-based economist discusses rising prices, how much to expect they will go up and whether they could prove permanent, how the Fed might react, and what to watch as we track the consumer price index, or CPI, that basket of goods that includes costs of a variety of consumer products and services, like energy, food, transportation and medical care. All of these areas are now seeing different price trends, after more than a year of a raging pandemic, lockdowns, social distancing, work-from-home policies, stimulus spending and, now, signs of recovery.
The following has been lightly edited for clarity and brevity.
TheStreet: A big real estate investor, Sam Zell, recently said he sees similarities to inflation of the 1970s. It seems hard to see how that is possible….
McKeown: So we’re expecting some inflation, but we are thinking of a rise to perhaps 2.5% or 3% in the US – nothing like the rates of 10% or more that we saw in parts of the 1970s. There are a few key differences that make us think that kind of surge is unlikely now. Trade unions are less prominent, there is less wage indexation and labour and product markets are more competitive. There is more global competition now, which has also reduced workers’ pricing power. And central banks’ credibility and confidence in inflation-targetting has grown significantly since the 1970s.
Also, demographically, we’re in a very different position now from the one we were in 50 years ago. The ageing of populations in advanced economies has meant an increased demand for savings versus spending and that, too, has reduced inflationary pressure. That balance will shift only very gradually as people retire.
TheStreet: Now, there’s a debate over whether inflation is transitory or not. We’ve seen several headlines just this past week arguing one way or the other and some are looking at lumber prices and other raw materials costs. Are you able to give some perspective on that, at least on inflation in the U.S.?
McKeown: The effects related to lumber and to steel, which has risen very sharply, those should prove transient.… They’ve risen so high already, that they should be due to come back a bit. One issue in metals, for instance, is that steel production in the U.S. is still relatively depressed. It takes a very long time for it to come back on stream after the kinds of lockdowns and closures that we’ve had. So, it’s not that surprising that we see increases in prices, but those should come off.
The big question, though, is not whether these commodity prices go up and up and up, but their impact on prices and on manufacturers’ costs. We are starting to see in business surveys that show manufacturers are starting to say that they have had a very sharp increase in their costs, and they’re starting to pass that through to consumers. The question is whether those price increases start to generate other price increases, and, in particular, do they start to play a role in wages?
Even a temporary rise in commodity prices can have an effect on wages, if people are seeing those high bills – whether it be on fuel or food – and then demand higher wages because of it. And then, whether the labor market is in a strong enough position to grant those wage increases.
So, that is the big question now. What we’re seeing is that in the U.S., there are some signs over growing wage pressure and there are some signs of labor shortages, which would be expected to generate some wage pressure. But outside the U.S. – in Europe, for example – that is not the case. The risk of sustained inflation is much higher in the U.S. than in Europe.
TheStreet: Is it possible the pandemic could add to unknowns in employment that could affect inflation? For example, what if a significant number of people who were working in restaurants or retail or even teaching decide they want to change careers after a year of disruption?
McKeown: It could, but it depends really on the extent of mismatch between the jobs people are wanting and the jobs that they are qualified to do – and the jobs that are available. If there are fewer people who want to work in restaurants, for example, then that is going to put further upward pressure on prices at a time when we know that capacity restraints are already boosting prices a bit. ...If there are also labor shortages, it would exacerbate what is already quite a difficult situation.
TheStreet: On that note, we’ve heard renewed calls to raise the minimum wage not so long ago. Whenever the idea of raising the minimum wage is brought up, you get pushback, with people saying it would raise inflation. Does it?
McKeown: Raising the minimum wage doesn’t necessarily lead to inflation. It’s a one-off increase. It would boost wages in a one-off way, which then would then drop out of the year-on-year comparisons in a year’s time – unless you’re in an environment where that shift in the minimum wage causes others to call for higher wages as well, and you end up in a wage-price spiral where everyone is bidding up their wages – and prices are going up at the same time. I think that’s the fear that that kind of thing could happen, but I’d say that there is little danger for an aggressive wage-price spiral in the U.S. at that this time. We’re in a very different place than say in the 1970s, when there was a very pronounced wage-price spiral and hyperinflation. That was driven by various factors, but mainly institutional ones: Unions were much stronger and there was much less global competition. An increase in the minimum wage would undoubtedly raise the average wages and boost inflation temporarily.
TheStreet: Let’s shift over to this idea of central banks’ role in what plays out. I saw an opinion piece recently that made the argument that central banks are not as concerned with inflation right now as they were in the past. What are your thoughts on that?
McKeown: I do think that their priorities are changing. We’re coming, of course, from a position from where central banks in advanced economies were very single-mindedly focused on inflation – a decade ago it was very much on that one aspect. The Fed’s mandate has ... broadened … it’s now shifted to an average-inflation target from a point-inflation target, which gives it more flexibility and more ability to tolerate higher inflation for a limited period, if it believes it can bring it back down in the future. But it’s also broadened to considering the labor market more explicitly, and looking for an inclusive labor market recovery, which means it’s going to be looking for more than a fall in the unemployment rate, it wants it to affect all parts of the social spectrum. It’s starting to think about inequity a lot more and to consider allowing the economy to run a little hotter for a while in order to get everyone back … into employment. So there’s a lot more going on. So there’s a lot more going on with the Fed, and other central banks, too. The Bank of England is starting to think about climate change and the Reserve Bank of Zealand now has stabilizing house prices as a part of its mandate. There is pretty clear evidence that central banks’ sights are broadening and they may well be prepared to tolerate higher inflation for a period to pursue other goals.
TheStreet: We also have the rise in used car prices in the U.S. and we have other prices, like housing, that seem out of reach for many Americans. But not all of those are factored into current inflation calculations, right?
McKeown: Car prices are in there, as a part of the CPI, but they are a relatively small share. So, for a small family saving up to buy a car, it may seem like a bigger deal – a sharp increase in car prices – than it would appear from the relatively small share they are of the average CPI basket every year.
But houses, they are not explicitly factored into the CPI. Most statistics agencies will put some measure of rent, some measure … of the cost of housing services into the CPI, but no house costs directly. So, sharp increases in house prices won’t show up, and that’s one of the reasons why the Reserve Bank of New Zealand has been asked to explicitly target house prices. The government felt that the pure focus on CPI wasn’t enough to be able to help people to afford homes. Therefore it has tasked the central bank with tightening policy if need be, just to keep housing prices under control.
TheStreet: There’s seems to be an irony now – that the people who are ringing alarm bells about inflation right now seem to be those with the most, when aren’t they the least likely to really be affected by a 2.5% or 3% rise in costs? Someone who’s poorer or on a fixed income would be much more hurt by inflation, right?
McKeown: I’m sure that’s right. … A relatively small increase in prices in things that are completely essential like fuel could make a really difficult problem. What investors are thinking about when we talk about inflation is the probably that the Fed would respond with a sharp increase in the interest rates, that … could be a good or a bad thing. At this point, it doesn’t look like the Fed is going respond quickly to the rise inflation that we’ve seen. But that’s very much hinged on the idea that it’s transient, and I think that could change very quickly. I we were to see a significant uptick in wage growth, which would signal that the rise in inflation is going to be relatively sustained.
This story has been updated and edited. The first answer has been updated and clarified as well.