Investors are worried about inflation data, but economists see it as a sign of temporary growth

May 12, 2021

For years, economists worried that broad macroeconomic changes — an aging population, fewer babies, the advent of automation — would keep prices anchored for decades.
But with the Labor Department's most-recent inflation print spooking stock markets, investors are antsy about a return of inflation.
The recent pickup in inflation may, in fact, be a temporary — and welcome — change for those who fear a slowdown in U.S. GDP.

A little inflation might not be such a bad thing, after all.

With the Labor Department's inflation report Wednesday spooking stock markets, and traders blaming rising prices for a broad sell-off in technology shares, attention has once again centered on how much Americans are paying for the totality of the things they consume.

The recent pickup in inflation may, in fact, be a temporary — and welcome — change for those who fear a slowdown in U.S. gross domestic product. Inflation, when controlled, is often a healthy byproduct of a growing economy, so its dormancy for much of the past decade has raised a few eyebrows.

For years, economists worried that broad macroeconomic changes — an aging population, fewer babies, the advent of automation — would keep prices anchored for decades.

Even some of Washington's most expansive fiscal and monetary stimulus couldn't seem to do the trick.

Despite the 2010 passage of the Affordable Care Act, an acceleration in federal debt from 52% of GDP to 74% between 2009 and 2014, and the Fed holding interest rates at zero, sustained inflation evaded lawmakers for most of President Barack Obama's two terms.

To be sure, prices have, from time to time, exceeded the Federal Reserve's 2% target over the last decade. Between December 2011 and April 2012, the central bank's preferred inflation measure, the core personal-consumption expenditures index, exceeded that target.

But the type of robust, long-lasting inflation the Fed now seeks has, until recently, faded from memory. By that measure, inflation has only met or exceeded the central bank's 2% target 14 times over the 121 monthly readings taken over the past decade.

Though economists didn't know it then, April 2012 would be the last time President Barack Obama would see inflation above 2%. Price growth remained firmly below the threshold until well into President Donald Trump's term.

On face value and taken in isolation, the government's inflation report Wednesday could be unsettling. The Bureau of Labor Statistics showed that CPI accelerated at its fastest pace in more than 12 years in April.

Growth-oriented companies, which tend to get hit hard by rising inflation via the Fed raising interest rates, sold off across the board ahead of and after the report. The Nasdaq Composite is down more than 5% in May alone.

And now, with trillions of Biden bucks pulsing through the economy and the Federal Reserve holding interest rates near zero — Wall Street is getting cold feet about a return of inflation.

To an even greater extent than they did during financial crisis more than 10 years ago, policymakers on Capitol Hill and at the Fed have worked together to counter a pullback in demand to mitigate the impact of the Covid-19 pandemic.

Trillions have been spent on various ways to curtail both the virus and its depressive impact on U.S. business. Multiple rounds of stimulus checks, ramped-up unemployment benefits and eviction moratoria have all been deployed in the name of fostering Americans' demand to spend money and save small businesses.

With more than half the U.S. population vaccinated and businesses reopening, the Biden administration continues to advertise its infrastructure and family bills as urgently needed stimulus.

President Joe Biden reiterated that message on Friday, after the government reported a far-weaker-than-expected April payrolls figure.

"Today's report just underscores, in my view, how vital the actions we are taking are," the president said. "Our efforts are starting to work, but the climb is steep, and we have a long way to go."

Silver linings

While equity traders may be grumpy about inflation's potential to erode the purchasing power of future profits, economists are trying to remind the world of a key couple facts: Inflation is often a byproduct of economic growth and is likely temporary.

In fact, it may even be good for the economy if a cocktail of monetary and fiscal stimulus is still able to trigger both inflation and fears of inflation, according to economist and former Treasury Department official Nathan Sheets.

"My sense is that Jay Powell and his colleagues at the Fed are quite relaxed about the prospects for inflation," Sheets, who once served as under secretary of the Treasury, wrote on Tuesday.

Sheets, now chief economist at PGIM Fixed Income, noted that for much of the past 10 years, central banks have been struggling to generate healthy price growth.

"The Fed has been in a pitched battle to get inflation up. Even if the rise in actual inflation is temporary, it could still be helpful for them in achieving their target," he added. "At a minimum, the second half of this year will show that it's at least possible for modern economies to generate inflation — which is something we haven't seen for many years."

As sluggish as inflation has been in the U.S. over the years, the domestic situation is still far better than that overseas.

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The long game

The real economic trouble may, in fact, be hidden in the back half of Brainard's quote.

Prominent economists, led by former Treasury Secretary Larry Summers, have repeatedly warned that temporary bursts of inflation do not fix the underlying macroeconomic changes, like automation and decelerating population growth, that have kept it under target for so long.

Summers believes that the U.S. economy is in the middle of what's known as secular stagnation.

Unlike the regular ebbs and flows of economic cycles that happen every few years, Summers argues that the U.S. is in the middle of a slow, gradual process that will ultimately result in lower long-term GDP and inflation growth.

"There is, I think, another aspect of the situation that warrants our close attention and tends to receive insufficient reflection. And it is this: The share of men or women, or adults, in the United States who are working today is essentially the same as it was four years ago," Summers told an assembly of economists at the International Monetary Fund in 2013.

Even a mammoth influx of cash from the Biden administration and the Fed cannot change the long-term impacts of, for example, declining U.S. birth rates and, in turn, no longer a need for so many factories, shops and businesses.

Easy money cannot indefinitely foster the same level of real GDP growth if population growth is stagnant or declining.

In that case, Summers began to argue in 2013, the real equilibrium interest rate may actually be negative. He reiterated his theory as recently as last month, when he spoke to the Financial Times.

"I looked at the global economy and, indeed, at the U.S. economy during the pre-Covid period and what I saw was that, at near-zero real interest rates, there was a quite substantial gap between private savings and investment, driven by demography, cheap capital goods, inequality and technology," he told the paper.

Here Summers is saying that savers have moved more and more cash out of traditional savings accounts because would-be investors simply did not desire additional funds, a fact that could lead to negative real interest rates.

Negative rates can imply that the current level of investment in the economy — the number of factories, houses and other capital — is too high given what businesses and consumers actually require.

"That substantial gap meant a deflationary tendency, one towards sluggishness and for savings to flow into existing assets and create asset bubbles," Summers told the FT last month.

Kelly Friendly, a spokesperson for the former Treasury secretary, did not respond to CNBC's request to speak with Summers.

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