Cut the Fed Some Slack: Inflation Will Be Transitory And Economic Growth Will Pick Up Again

With apologies to William Shakespeare, transitory or not transitory, that is the question. For months now we have been listening to Federal Reserve Chair Jerome Powell tell us that inflation is transitory. For that reason, he has delayed tightening monetary policy. After a prolonged period of virtually no inflation and negative real interest rates, Powell and most Fed officials believe that a little inflation is good for the economy and that there is no reason to fear that the current inflation we are experiencing will get out of hand.

At the same time, other well-regarded economists say that the Fed is already behind the curve. They want the Fed to act now and to act decisively. These economists argue that inflation is like a genie. Once it gets out of the bottle, it is impossible to put it back. And if the Fed waits much longer, the inflation genie will have escaped.

There is no question that prices are rising. According to the most recent GDP report, the PCE Price Index increased 6.5% in the second quarter. Wages are rising too. Average hourly earnings are up five months in a row to a new high of $30.73 per hour. Higher wages are good news for many workers, but they add to inflation fears.

Furthermore, GDP growth is slowing. After the pandemic shutdown of 2020, we knew that GDP figures would look impressive once things started getting back to normal. Indeed, GDP surged 33.8% in the third quarter of 2020. But that was an aberration. More recent results show that GDP is growing at just under 6%. Still impressive by historic standards, but less than what was expected. In fact, the Atlanta Fed just reduced its forecast for third-quarter GDP growth from 5.3% to just 3.7%. Other economists are also reducing their growth forecasts. In addition, the most recent employment report was disappointing. Nonfarm payrolls climbed by just 235,000, much less than the 750,000 that was expected. All of this raises the specter of stagflation, that dreaded economic condition characterized by slowing growth and rising inflation.

Even so, I remain optimistic that the Fed is right. I got further encouragement from the most recent sales figures from Ford Motor Company ($F). Ford said it sold 124,176 vehicles in August, down 33% year over year. Doesn’t that mean that demand is plummeting? How can that be encouraging?

It turns out that demand is not the problem. In fact, demand for Ford vehicles is extremely strong. For example, its new F-150 Lightning pickup truck, an all-electric vehicle, already has 130,000 reservations. The real problem is lack of supply. Ford has had to shut down plants because it can’t get the semiconductors (chips) it needs to complete the production of new vehicles. There is a worldwide chip shortage and that is wreaking havoc on all kinds of manufactured products – not just vehicles. In fact, demand is so strong that Ford’s average transaction price jumped $9,700 or 24% from a year ago to $50,800 per vehicle.

Ford’s situation is an excellent reflection of what is happening economy-wide. Demand for most goods is extremely strong but supply chain disruptions caused by pandemic-related shutdowns from a year ago have made many goods scarce. The Delta variant of Covid-19 is adding to our current economic woes. Without these supply-chain disruptions, we would likely see GDP growth at much higher levels and inflation at more moderate levels. I’m willing to cut the Fed some slack. If the Fed is right, once the supply chain constraints are alleviated, inflation will indeed prove to have been transitory and economic growth should pick up again.