Anyone looking for good economic news will be disappointed by the latest inflation report, which showed the Consumer Price Index (CPI) advancing by 0.5 percent in January. By itself, this isn’t especially alarming – prices jump around month to month – but it has troubling implications for the future. To some economists, it suggests the possibility of another financial crisis on the order of the 2008-09 crash.
Until recently, inflation seemed to be dead or, at least, in a prolonged state of remission. It was beaten down by cost-saving technologies and a caution against raising wages and prices instilled by the Great Recession. From 2010 to 2015, annual inflation as measured by the CPI averaged about 1.5 percent, often too small to be noticed. In 2016 and 2017, the annual rates inched up to 2.1 percent. On an annualized basis, January’s 0.5 percent would be 6 percent.
It’s doubtful that many economists believe that inflation is now so high. Remember those erratic month-to-month swings. But the pervasive nature of the inflation suggests that supply is shrinking compared with demand. This enables businesses to raise prices. The January gains, wrote Ken Matheny of Macroeconomic Advisers, were “broad-based, with increases in … apparel, used cars and trucks, shelter, medical care services and transportation services.”
Inflation’s rebound seems to vindicate former Federal Reserve Chair Janet Yellen, who argued that price increases were in hibernation, not the mortuary. Now, her successor, Jerome Powell, faces the tricky task of containing inflation without killing the economy.
The traditional Fed response to rising inflation has been to cool the economy. Interest rates go up; money and credit growth go down. This is almost always unpopular.
Still, the Fed has already indicated it may raise short-term interest rates three times in 2018, and even if it balks, long-term rates on bonds and mortgages may rise anyway. The reason: The so-called “bond vigilantes” – bond buyers – will insist on higher rates to compensate for the inflationary erosion of the value of their money. Rates on 10-year U.S. Treasury securities have already moved to about 3 percent, up from 2.5 percent in early 2018.
What’s scarier is the possibility that higher inflation and interest rates will trigger a global financial crisis – some mixture of stock market collapses, bond and loan defaults and banking failures. Yet, at a recent conference hosted by the American Enterprise Institute, some experts suggested this dismal outcome.
“Global debt levels [are] higher today than in 2008,” said economist Desmond Lachman, a former official at the International Monetary Fund now at AEI. He contended that major central banks – the Fed, the European Central Bank and the Bank of Japan – kept interest rates too low for too long, pouring $10 trillion into the global financial system since 2007.
“Lofty [stock market] valuations only make sense at low interest rates,” Lachman argued. This creates a dilemma for the Fed. If it raises interest rates to combat inflation, it risks depressing the stock market and triggering a recession. But if it does nothing, inflation may worsen and cause a broader crisis.
William White of the Organization for Economic Cooperation and Development sounded a similar theme. “In the last 30 years,” he said, “the real driving force [of economic growth] was demographics – we had a combination of baby boomers coming [into the U.S. economy] and China” joining the world economy.
Now, these forces are ebbing, White said. The baby boomers are retiring; the biggest part of China’s impact has already occurred. To sustain economic growth, governments have resorted to easy credit. But mixing higher debt and lower economic growth may be unstable; some borrowers may default on their loans and bonds.
The Fed may be trapped; whatever it does – or doesn’t do – carries risks. Of course, these dire predictions may not come true. They may be undone by skillful policy, good luck and unforeseen circumstances. But whatever happens, we know from history that containing inflation is an urgent task.
There is something dangerously seductive in accepting “just a bit more inflation” as a tolerable cost for lower unemployment and more economic growth. These promises are illusory, but they were believed by economists and political leaders in the 1960s and 1970s.
It was a disaster. Inflation crept up from about 1 percent in 1960 to 13 percent in 1979. During these decades, we experienced four recessions (1969-70, 1973-75, 1980 and 1981-82) and the pervasive uncertainty of not knowing what our incomes and savings would be worth, month to month.
Most Americans hated high inflation. It was not only bad for the economy, it also subverted our self-confidence and faith in national leaders. Its defeat in the 1980s, albeit with a harsh recession, was a major triumph that we shouldn’t have to repeat.
Robert J. Samuelson is a columnist for the Washington Post Writers Group and the author of “The Great Inflation and Its Aftermath: The Past and Future of American Affluence.”