Inflation waves

It’s Fed week. And while Fed Chair Powell and the members of the FOMC are most attentive to recent data on growth, the labor market and inflation, they know the longer-term history of inflation too.

This week’s chart shows three periods in our domestic economy’s history: 1910, 1939, and 1972, along with the most recent period, which began in 2019. There is no guarantee that the future will look like the past, but past periods of inflation have come in waves, with second and third waves of inflation that went to higher levels and required tighter monetary policies to bring down. My personal memory is of the tail end of the 1972 period when Paul Volker was the Chairman of the Fed and was holding rates very high, 20% plus, even as the economy was in a recession and the unemployment rate in the U.S. exceeded 10%. It was awful medicine and a very painful economic period that influenced monetary and fiscal policy for decades. This Fed does not want to see that happen again.

The onset of the pandemic led the Fed and Congress to pursue highly accommodative actions, which were successful in blunting the negative implications of the economic shutdown but introduced the inflationary forces we now face. As the Fed thinks about its moves from here, their thoughts will be not only on the impacts in the short run but also on what they might be over the longer term.

With this chart as our history, it may very well mean the Fed is slower to react to an onset of economic weakness than that to which we have become accustomed in the last 15 years. Past Fed’s, it would seem, have eased monetary policy too soon and set the table for inflation to come back. Past waves of inflation occurred months, even years, after initially falling, so we may have a period where it seems inflation is “under control” or “anchored” only to see it flair again. The Fed has raised rates significantly, but the ongoing lack of fiscal discipline might very well increase the chances for future inflation despite restrictive Fed monetary policies.

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