Global| May 03 2021The Fed's "Base-Effect" Inflation Argument Is Nonsense
|in:Viewpoints
Summary
Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics. Federal Reserve Chairman Jerome Powell has played down the current runup in inflation, arguing it is associated with the reopening [...]
Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
Federal Reserve Chairman Jerome Powell has played down the current runup in inflation, arguing it is associated with the reopening of the economy. And as the low inflation readings of one year ago drop out, the twelve-month calculation (i.e., the so-called base effect) of reported inflation is likely to move up in the coming months.
Yet, Mr. Powell's "base effect" inflation argument is nonsense. For the "base effect" argument to be correct, the twelve-month reading of reported inflation should be markedly lower when the economy was closed than what occurred before the pandemic. But that's not the case.
Last week, the Bureau of Economic Analysis reported that the twelve-month change ending in March 2021 in the core personal consumption index (the Fed's preferred price index) was 1.83%. That compares to the 1.87% reading for the year ending in February 2020 and 1.7% for the year before that.
The 1.83% reading for twelve months ending March 2021 essentially matches the average inflation rate of the two prior years. And that 12 month period includes the three months (April to June) when the economy was closed, and GDP plunged a record 31% annualized. How could there be a "base effect" on reported inflation when the base year has the same inflation rate as it did before the pandemic?
Mr. Powell's "base effect" inflation argument has not been questioned or challenged by analysts or reporters. Regardless of that, investors need to ignore the Fed's rhetoric and treat upcoming price increases as "new" inflation.
As nonsensical as the explanation for the uptick in inflation, so too is the remedy. Demand has always been the primary force behind broad inflation cycles. Yet, Mr. Powell argues that product price inflation will ease once manufacturers increase output and eliminate "supply bottlenecks," and home inflation will slow once builders build more homes.
It's hard to see how more supply (or growth) will slow inflation anytime soon. Federal Home Loan Mortgage Company (Freddie Mac) estimates that the US needs almost 4 million new homes to meet demand. That could take two to three years. Also, it's hard to see how increasing product output will solve the inflation problem. The supply-side argument solution; fight inflation with more demand and more commodity inflation.
The Fed's mantra has always been "inflation is everywhere and always a monetary phenomenon." But nowhere in Mr. Powell's statements or comments do you find any monetary policy role for increased inflation or any responsibility for containment. Investors forewarned.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.