Inflation Returns

Inflation is back and worse than it's been in decades. Consumer prices rose 0.9% in October and are up 6.2% in the last twelve months. Two more months of moderate increases, and the CPI will be 6.5% in 2021, the highest inflation since 1982.

As a result, after surging in the earliest stages of the pandemic, "real" (inflation-adjusted) average hourly wages have been trending downward since peaking in April 2020 and are down 1.2% in the past year. In fact, real average hourly wages are up only 1.5% since February 2020 (pre-COVID) versus a gain of 2.3% in the twenty months before COVID arrived.

One of the Keynesian justifications for applying a very loose monetary policy was to run the economy "hot," in order to offset damage from COVID itself and pandemic lockdowns. But this has apparently backfired as inflation accelerated rapidly. It looks like workers are the ones getting burned.

The Federal Reserve, however, says inflation is going to drop next year. And we think the Fed is probably right about the direction of inflation; prices should go up next year, but not as fast as this year.

Why? Think of oil, for example, which ended last year at $48 per barrel (for West Texas Intermediate) and closed on Friday at $81. Could oil prices move up again in 2022? Sure. Will they go up almost 70% like they have so far this year? Probably not. Then there are the massive supply-chain issues, particularly with computer chips, that have disrupted the automobile market. Prices for new cars and trucks are up 9.8% from a year ago; prices for used cars and trucks are up 26.4%. Higher semiconductor production should curb price increases next year and prices might even fall modestly in this sector.

The problem is that the most recent forecast from the Federal Reserve (released September 22) suggests its favorite inflation measure will only be 2.2% next year, which translates into an increase of about 2.5% for the Consumer Price Index (CPI). Sorry...put us down supporting the "Over."

We think the Fed is making the same mistake it made last year. At the end of last year, the Fed projected that its favorite measure of prices would be up 1.8% in 2021, which translates into roughly a 2.0% increase in the Consumer Price Index (CPI). Oops! Not even close.