What to do?

Even with everyone and their dog braced for higher inflation, today's US CPI print for October was a shocker.  Headline CPI rose 6.2 per cent from a year ago, the biggest year-on-year gain since 1990.  Although the focus has mainly been on energy and food costs, the report makes it clear that inflation pressures are much more widespread than that. Core CPI, which excludes both of those categories, rose 4.6 percent. Nor is there any consolation in the month-to-month figures: headline CPI rose 0.9 percent in October alone, with core up 0.6 percent. Both of these numbers were higher than in September, and both annualize to much higher rates than the yearly numbers reported today. 

It's easy to revive the old monetarist shibboleths here: "inflation is always and everywhere a monetary phenomenon", and "too much money chasing too few goods".  Needless to say, those points are already being trotted out, but the situation is a lot more complicated than that. It's well and good to point to the massive stimulus package launched last year in response to the pandemic during the Trump administration, but it is hard to argue that providing much less stimulus would have led to a better outcome. Most likely the US would now be facing a severely depressed economy, with few tools at its disposal to get things moving again.

That said, the data do cast some doubt on the wisdom of the Biden administration in pushing for yet more stimulus, in the shape of the infrastructure bill and the still-pending Build Back Better package. There is no doubt that part of the current inflationary surge stems from the demand side of the economy, as reopening of the economy induces Americans to spend the cash they accumulated earlier in the pandemic.

In Canada, Finance Minister Chrystia Freeland  described unspent COVID benefits as "pre-loaded stimulus".  Although US support programs were smaller than Canada's, the same logic applies there, and would seem to suggest that the economy is rapidly getting back on track without the need for further government stimulus. 

It is, of course, the supply side that has been receiving most of the attention for media and economists alike as the primary driver of inflation. The examples are legion, ranging from a semiconductor shortage that is cutting auto production, to wide-ranging problems in the supply chain itself (shortages of shipping containers and truckers), to inadequate production of oil and gas as economies recover from the COVID-induced collapse in demand.

In the light of history, it's not surprisingly that President Biden seems likely to focus on this last item. Fresh from lecturing the world at COP26 just over a week ago, he is demanding that OPEC ramp up its oil output in order to save Americans from pain at the pumps, an appeal that has so far fallen on deaf ears.  He also seems to be mulling the possibility of releasing oil from the Strategic Petroleum Reserve in Louisiana, though that's hardly the purpose for which the Reserve was established. 

If the White House can't do much to help (and may even be adding to the problem with its stimulus plans), it falls to the Federal Reserve to try to get inflation back under control.  Governor Jerome Powell's pledge to allow inflation to remain above the 2 percent target in order to foster economic recovery always seemed a little foolhardy, but we can hardly expect him to morph into Paul Volcker and start pushing rates through the roof.

Nor is it clear that he should. Raising rates might put something of a crimp into the demand side of the inflation problem, but that may soon calm down anyway as the savings built up earlier in the pandemic get spent. And there's no reason to think that higher rates would do anything to help ease supply chain pressures, many of which originate outside the United States.

This is not to say that the Fed can just sit on its hands. Powell's description of inflation pressures as "transitory" is looking more ill-advised by the day, but the forces behind those pressures are not easily addressed by monetary policy. The risk for the Fed is that inflation expectations start to move way above its 2 percent target. Movements in fixed income markets suggest that is starting to happen, and that is something the Fed can address. The lethargic pace of tapering QE may well have to be stepped up in short order, and Chairman Powell's rhetoric is going to have to become a whole lot more hard-edged. 

The situation is nowhere near as dire as in the 1980s, but both Governor Powell and I lived through that era, and I think he would agree that we don't want to go back there. Over to you, Jay!