![]() Commodity prices fell sharply during last year’s first four months only to recover in the months that followed. This is because, as shown in Chart 1, the Consumer Price Index (CPI), a widely followed measure of inflation, is strongly correlated to commodity prices. Unfortunately, the coming months’ inflation reports will only muddy the picture. (Think supply.) How the two balance out will determine where inflation goes from here. ![]() ![]() (Think demand.) On the other side, the economy still has tremendous amounts of unused capacity, with sales at restaurants, hotels, and other businesses still well below pre-pandemic levels. On one side, we have a historic increase in money supply coupled with massive government spending reaching the economy just as it is about to fully reopen. Whether Chairman Powell is correct comes down to the economic basics of supply and demand. In fact, the Federal Reserve raised its longstanding 2% inflation target to a level moderately above 2% for an extended time to offset the prior period of lower inflation. He further noted that any inflation it may cause is transitory. And where does this money come from? It comes from more debt and more money printing, thereby stoking inflation fears.įederal Reserve Chairman Jerome Powell has said that this additional stimulus and money printing, along with near-zero short-term interest rates, are necessary because we are still in the reflation phase of the recovery. economy’s annual production, is in response to a much smaller 2.4% economic decline in 2020. That $2.8 trillion, equal to 13% of the U.S. So in December and March, Congress passed two more large spending bills, dropping a combined $2.8 trillion into the economy at a time when, thanks to vaccines and an easing of restrictions on businesses, it was already on a path to recovery. Policymakers have decided that if one large dose of medicine was good for the patient, then more large doses will be even better. And it worked!īut here is where inflation concerns come into the picture. On the fiscal side, Congress provided people with direct stimulus checks to replace lost wages or, for those still employed, boost spending and investment. On the monetary side, the Federal Reserve created huge sums of new money while lowering interest rates both to encourage borrowing and to discourage leaving money in savings. ![]() government used both monetary and fiscal measures to battle the deflation threat and reflate the economy. Deflation is generally viewed more negatively than inflation-at least moderate inflation- because it makes meeting debt obligations more difficult and it incents people to delay spending in anticipation of falling prices. The sudden sharp drop in consumer and business spending combined with falling financial markets threatened not only to push the economy into depression, but also to begin a period of deflation, or falling prices. At the pandemic’s beginning, policymakers viewed deflation, not inflation, as a major threat. Understanding why many investors are beginning to worry about inflation requires a review of the policy measures used to combat the negative financial effects of this past year’s pandemic. And the most prominent reason of late is rising prices, otherwise known as inflation. economy is projected to grow at its fastest rate in decades and corporate earnings are expected to increase by double-digit rates, it should come as no surprise that investors have found new reasons to worry. Beginning with panicked selling set off by the pandemic, the period ended with stock market indices sharply higher and many high-promise-but-no-earnings stocks reaching bubble-like valuations. The past 14 months illustrated that better than any period in recent memory. Investing is a never-ending struggle between worry and optimism.
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