Inflation is bad now – but the Fed could take us back to the 70’s

So much for Federal Reserve Chair Jerome Powell’s repeated assurances over the past year that inflation would prove to be non-existent a transitional phenomenon. So much for our hope that the economy, the stock market, and our 401(k)s will be smooth sailing when we finally recover from a two-year pandemic. Powell now faces some difficult decisions.

Thursday’s dreadful CPI numbers show that inflation is broad and shows no signs of retreat. This does not bode well for the economic outlook for the year and for the stock market prices, which have fallen sharply since the beginning of the year.

In fact, while Team Biden downplays the depressing data, the news is particularly concerning because it comes at a time of heightened financial market volatility — and because of the Russian invasion serious impact the international commodity prices are not yet reflected in the consumer price index.

Consumer price inflation is now running at a hair’s breadth width under 8%, according to the Department of Labor. That’s the highest rate of inflation since 1982, when Ronald Reagan was President. It’s also about four times the Fed’s definition of 2% of a desirable inflation rate.

But as bad as Thursday’s inflation numbers are, we must brace ourselves for worse to come in the months ahead.

President Joe Biden
President Joe Biden is idiotic to blame Russian President Vladimir Putin for his self-inflicted economic woes.
EPA/Yuri Gripas/POOL

President Joe Biden claimed Thursday that “today’s inflation report is a reminder” that “families are beginning to feel the impact of Putin’s price hike.” But inflation was already posting record increases before Russian President Vladimir Putin invaded Ukraine – 7.5% last month. Biden pumped unprecedented trillions into a peacetime economy, and the Federal Reserve continued to print money to fund the deficit. Such a huge increase in the money supply would certainly trigger inflation.

Now the Russian invasion will also take its toll. It’s not just that international oil prices are up 60% since the beginning of the year to around $120 a barrel. It has also caused a sharp increase in International food prices and in the cost of key industrial metals such as aluminum, nickel, platinum and palladium. The impact will be far-reaching – hitting the most vulnerable hardest. Of particular concern to low-income earners is the fact that wheat prices are up more than 60% year-to-date.

It is particularly remarkable how quickly the increase in international oil prices can be felt at the pump. In the past two weeks, gasoline prices have risen about 20% from their current national average of about $4.35 per gallon. That increase in gas prices alone could add three-quarters of a percentage point to consumer price inflation next month.

A person shops for groceries at Lincoln Market in the Prospect Lefferts Garden neighborhood of the borough of Brooklyn on March 10, 2022 in New York City.
Americans aren’t the only ones suffering from more expensive grocery products as international food prices soar.
Michael M Santiago/Getty Images

When the Fed meets next week to decide what to do about interest rates, inflation won’t be the only issue on its mind. It also has to worry about signs that equity and credit market bubbles, created by the Fed’s aggressive bond-buying program now appear to be in the process of deflation.

The S&P 500 has been since the beginning of the year and the NASDAQ have lost 12% and 20% in value respectively. Meanwhile, market volatility and interest rates on risky loans are increasing in a way that could create tensions in financial markets.

All of this puts the Fed in a dilemma. If it raises interest rates aggressively, it might be able to get the interest inflation spirit back into the bottle – albeit at the risk of a disorderly bursting of stock and credit bubbles.

If the Fed, on the other hand, acts timidly to the interest it could help stabilize financial markets – but it would do so at the risk of losing control of inflation. Losing control of inflation would, in turn, prepare us for a hard economic landing when accelerating inflation eventually forces the Fed to slam on the monetary brakes.

Judging by the Powell Fed’s track record to date, being excessive confident about inflation At risk, I expect the Fed to embark on a rate breeding path that will leave interest rates very negative when adjusted for inflation. If that’s the case, we should brace ourselves: there’s going to be some stuff in the stock market that could weigh on our 401(k)s. Worse, we could be in for a prolonged period of inflation not seen since the 1970s.

Desmond Lachman is a Senior Fellow at the American Enterprise Institute. Previously, he was Associate Director in the Department of Policy Development and Review at the International Monetary Fund and Senior Economic Strategist for Emerging Markets at Salomon Smith Barney. Inflation is bad now – but the Fed could take us back to the 70’s


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