Update 602 — Symptom vs. Disease:
Fighting Inflation by Relieving Costs
There is a difference between battling inflation, which is the Fed’s errand, and battling its effects, which is more of a fool’s errand. With prices up 8.5 percent from a year ago and midterm primary season starting next month, the temptation is to focus on easing costs to consumers and businesses. But the path of inflation is unpredictable and cost-cutting measures likely will be too little, too late.
The March CPI report, out this week, makes clearer the challenge of inflation in policy and political terms. Today, we examine the report’s implications and evaluate if we’ve hit the peak of inflation. We also look at what upcoming policy decisions surrounding inflation are ahead and what policies and pronouncements will be responsive to voters’ top economic concerns.
We note the administration announced Michael Barr’s nomination to Vice Chair for Supervision of the Fed this morning, opening discussion of the agenda and priorities progressives should have for the position.
Good weekends, all…
The March CPI report gave us the first signs that we may be approaching the other side of the inflation mountain. While overall inflation was 8.5 percent year-over-year and 1.2 percent month-over-month, inflation, excluding food and energy, rose only 0.3 percent month-over-month. That increase was less than markets expected and was the third month of a stepdown. Overall, prices rose rapidly in March; Putin’s war in Ukraine led to a nearly 20 percent spike in gasoline prices. It completely overwhelmed the easing of prices for used vehicles and other goods that have been severely affected by the COVID disruptions to supply chains.
We are not near the finish line. Some inflationary pressures continue to build such as housing costs. Moreover, the decisions policymakers make between now and the midterm election will have sizable consequences.
- Cost-Cutting Agenda: Lowering the price of energy, food, childcare, health care, and education must be at the top of Democrats’ priorities. Democrats must pass an aggressive agenda to cut costs for families, otherwise many voters will assume Democrats are not looking out for them.
- Monetary Policy: The Federal Reserve is trying to lower inflation by increasing interest rates, which should cool demand. However, moving too aggressively could lead to job losses and cause a recession. The recent easing in inflation and the strength of the labor market reduce the chance of a recession, but Democrats must prepare for the worst.
Both scenarios are huge risks for Democrats as November approaches: a lack of a clear agenda or a recession would surely be the nail in the coffin for Democrats’ chances of retaining Congress.
Good(s) For You
Energy prices were the largest contributor to inflation over the last month, accounting for nearly 70 percent of the month-over-month figure. The jump in energy prices alone accounted for 2.4 percentage points of the 8.5 percent year-over-year headline reading. Much of the blame can be attributed to Russia’s invasion of Ukraine, which cut off millions of barrels of oil per day from global supply. The immense volatility of energy prices is further accentuated when compared to the core CPI’s 6.5 percent year-over-year and 0.3 percent month-over-month readings, which exclude energy.
Durable goods have been a large part of this bout of inflation due to supply chain disruptions causing shortages and bottlenecks. But a drop of 0.9 percent over the month is a sign that these challenges may be easing. It’s the first time since January 2021 that durable goods prices have fallen. And with durable goods accounting for nearly a quarter of CPI, the drop is a significant sign of relief. A 3.8 percent drop in used vehicle prices, the first since mid-2021, is largely responsible for the fall in durable goods prices. However, apparel prices still rose 0.6 percent over the month, signaling supply chain problems are still present in this sector.
Services costs have been increasing steadily, with a 0.7 percent increase just over the last month. The figure could have been worse but a slowdown in housing and rental prices kept services inflation from reaching any higher. Rent slowed to a 0.4 percent increase following January’s 0.5 percent and February’s 0.6 percent increases. Housing is still a large part of the month-over-month rate, contributing 18 basis points, but it does seem mortgage rate increases have not hit the inflation measurements yet and may be reflected in future reports.
Contributions to Monthly Headline CPI Inflation
Source: Bureau of Labor Statistics, Council of Economic Advisors
Views from the Peak
Despite the high reading, the March CPI report may be the peak of inflation many have been waiting for. The downward pressure from durable goods will likely continue, assuming the current lockdowns in China are not overly disruptive to global supply chains, and that will have a significant impact on headline rates. The fall in gas prices since the beginning of April will also bring next month’s headline rate down and help headline and core CPI converge. In addition, year-over-year figures should start to drop partially due to base effects, low inflation baseline from still last spring distorting year-on-year figures.
Core CPI may already have peaked. In February, core CPI clocked in at 0.5 percent month-over-month, but that figure fell to 0.3 percent in March. While still higher than desired, the slowdown — largely due to the drop in durable goods prices — suggests supply chain snarls are easing and inflationary pressures may be receding. If the trend continues, core CPI should drop to stable rates and that will drag down headline inflation as well.
But we should remain vigilant about inflationary pressures. Energy and food remain particularly concerning even as we see the fall in gas prices over the last two weeks. Short-term measures to bring energy prices down are starting to end or dry up, and global oil prices are still highly volatile. And crises surrounding grain harvests around the world, compounded by elevated transportation costs, could cause food prices to rise faster. Interest rate hikes will likely cause mortgage rates to climb going forward, which will rein in rampant house price appreciation but erode affordability in the process.
As the foremost economic issue in voters’ minds, inflation seems likely to bear heavily on the midterms. Unlike unemployment rates or GDP growth, almost every voter can daily and directly feel the impact of inflation. A recent poll by The Associated Press-NORC Center for Public Affairs Research found that 69 percent of Americans believe that the economy is in bad shape, and 65 percent disapprove of the president’s handling of the economy. If inflation cools in the coming months, Democrats may have a chance of turning that around in time for voters to cast their ballots.
But a timely end to elevated inflation cannot be counted upon. Democrats’ plans to bring down costs might help alleviate some of the symptoms of inflation, but only in the long run — too late to change the narrative by November. Easing supply chain pressures may take time. Even if Democrats in Congress can reach a consensus on some pieces of their cost-cutting agenda, most of those ideas would take significant time to implement. In the short run, the president’s power to curb rising prices is limited. Biden can use the bully pulpit and antitrust policy to ease voters’ concerns and influence expectations, but he will face an uphill battle doing so.
The Federal Reserve’s plans to raise interest rates will also play a factor in how inflation plays out. If the Fed raises rates too quickly, it could trigger a recession headed into the midterms. With so many voters already critical of Biden’s handling of the economy, this would spell disaster for his party in the midterms. If, however, the Fed is able to stem inflation without triggering a recession, Democrats will have the opportunity to curb their impending midterm losses. Doing so will require smart economic messaging and relevant wins on the Hill. If they don’t want to hand Congress to Republicans in November, Democrats will need to be able to convince voters that they are the party that can change voters’ financial situations for the better.