Inflation is Unlikely to Improve Before Things Get Worse

The recently released inflation figures for August should give pause to those who keep touting isolated pieces of data to claim that things are improving and that the Fed will no longer need to raise interest rates to stem the inflationary price trend. The CPI came in at 8.3% for August (and the 16% trimmed-mean CPI, which removes short-term fluctuations, came in at 7.2%, the highest figure since they started publishing it).

If you consider how far the Federal funds rate is from those figures, at currently 2.5%, you get an idea of how much higher the monetary authorities will have to go before they begin to tame the beast. Even that will not be enough, because as history shows inflation takes a while to subside in people’s psychology even after the right policies and decisions are adopted.

History teaches us another relevant lesson. Minor fluctuations in monthly inflation figures mean little. If there is a drop in the official rate of inflation from one month to the next, as has sometimes happened in recent months, it does not mean that the trend will continue until the final inflation target is reached, nor does it mean that the figures cannot be quickly reversed.

Between 1973 and 1979, when inflation averaged 8%, the rate dropped from one month to the next 36 times. As we know, eventually Paul Volcker became head of the central bank and famously had to apply very painful medicine.

Yes, gasoline prices have dropped, another piece of data that many folks have taken to mean that inflation will soon subside, but even taking this into account the rate for August was very high. What matters is not so much that gas prices experienced an annual increase of 60 percent in June and the annual rate came in at 26% in August, but the fact that gas prices are considerably higher than they were a year ago and that structural supply and demand conditions for energy in general (and therefore gasoline) point to very hard times ahead. To believe that temporary fluctuations in the price of gas are a reason for the Fed to stop fighting the inflation it so diligently contributed to bringing about is to miss the overall picture.

For U.S. households, food, rent and energy are up much more than 8 percent annually (remember: the inflation figure is only an average). Food, for instance, is up 13.6% in one year. For households that make less than $50,000 a year—that is, for about 40% of U.S. households—expenses are already, or are soon to be, higher than incomes. Total household debt is a staggering $16 trillion, $2 trillion higher than in 2019, which means the stimulus money has long been spent and families across the country are using what they have left to catch up with price increases.

Considering that the savings rate is now, at 5%, the lowest it has been since 2009, one can only conclude that millions of Americans are reaching a point where they will have great difficulty making ends meet.

Households, of course, are not the only ones heavily in debt. So are corporations and so is the government. The U.S. federal debt, which now amounts to $30 trillion, will be much more expensive to finance as interest rates keep going up (and they will inevitably do, a fact of life that even Jerome Powell seems to be accepting). There is little room, therefore, for the Treasury to bail out main street.

One would love to see light at the end of this very dark tunnel. But after so many years in which fiscal and monetary policy have operated in la-la land, it is time to face reality. Bad policies have consequences. Here they are.