Starting with the April 2021 release, virtually every monthly Consumer Price Index (CPI) report has indicated some form of abnormally high inflation. For instance, the April CPI rose 4.2 percent over the previous 12 months, the largest year-to-year increase since the period ending September 2008. Similarly, the June CPI increase was the largest monthly change since June 2008, and the 5.4 percent annual increase between July 2020 and July 2021 was the largest yearly increase since August 2008.
The latest report continues this trend. It shows that the monthly CPI increased 0.9 percent in October, and the CPI rose 6.2 percent for the 12 months ending in October, the largest 12-month increase since the period ending November 1990.
Naturally, these price increases have many consumers worried, and it is not at all surprising that the latest CPI report prompted President Biden to respond that “Inflation hurts Americans’ pocketbooks, and reversing this trend is a top priority for me.” It is also not shocking that many people have been blaming the Federal Reserve for the price surge and clamoring for the Fed to tighten its policy stance to get inflation under control. Often it seems as though blaming the Fed for inflation—especially if they “printed too much money”—is practically a national pastime. (One former Federal Reserve economist accuses the Fed of being in denial and thinks that the central bank should have already started tightening its policy stance.)
In contrast, I have been urging caution, warning against the damaging effects of a prematurely tight monetary policy. The reason for this view rests on the underlying cause of the recent episode of inflation: unprecedented economic disruptions caused by the COVID-19 pandemic and the government’s responses. The pandemic (and the government shutdowns) caused unusually large and rapid swings in demand, as well as disruptions in the ability to supply goods and services.
Aside from the technical implications that these recent supply shocks have for an inflation-targeting central bank such as the Federal Reserve (which I’ll address below), these disruptions serve as a stark reminder that policymakers will not reverse the recent CPI surge unless their policies address the underlying causes of rising prices. This direct connection is why I have been arguing for targeted policies to lower price pressures, and against both profligate fiscal expenditures and prematurely tight monetary policy.
Nothing in the latest CPI report changes my policy prescription.
For the past several months, as demand has picked up, supply problems in a limited number of goods categories—which happen to be highly visible in consumer markets—have been responsible for the bulk of the increase in the CPI. In October, just three categories of goods are responsible for 46 percent of the overall CPI increase (food at 12 percent, gasoline at 22 percent, and used cars & trucks at 12 percent). Within the food category, the largest increases have been in several beef, pork, and poultry products. Rent accounts for another 19 percent of the overall increase, so just four categories explain almost two-thirds of the overall increase. (During most of the past 6 months, abnormally large relative price movements for a handful of goods have resulted in above-average changes in the overall CPI.)
Suppliers of most of these goods were heavily disrupted during COVID-19, both because of the virus itself and the government’s responses. There are also many long-standing regulatory/policy problems that have exacerbated the COVID-19 supply shocks, including restrictive labor, immigration, and trade policies. Policy responses to these supply shocks will be ineffective if they fail to directly address these problems, and they will be counterproductive unless they recognize that the economy is not in a typical demand-driven downturn.
Read the rest of this post →