Is the economy overheating? Are we about to revisit the painful economic conditions of the 1970s and ‘80s, when prices spiraled out of control? Has President Joe Biden irreparably damaged the economy?
These scary questions have been raised in recent days thanks to some data releases showing startlingly brisk price growth. The Bureau of Labor Statistics reported Wednesday that the consumer price index was 4.2% higher in April than it had been a year earlier. The next day, the bureau reported that the April producer price index spiked to 6.2% year over year. Both April reports showed the fastest price growth in more than a decade.
Reflecting more recent developments, fuel prices climbed this week, and gas stations throughout the Southeast have been siphoned dry as customers waited for hours to refill their tanks.
These developments follow high-profile warnings (including from some on the left) that Biden’s massive spending plans, plus the Federal Reserve’s commitment to ultralow interest rates, might lead to overheating and inflation. So it’s tempting to link these numbers to some bungled policy or other.
It could well be true that parts of the Biden fiscal agenda will have some inflationary effects; based on the limited data available, we don’t know yet, and I don’t want to suggest there is no risk of that outcome. But it’s also too early to freak out. So far it looks like prices are picking up not because there’s too much money sloshing around, but rather because of a bunch of temporary, idiosyncratic shocks and supply chain issues that seem unlikely to lead to self-sustaining inflation.
For instance: Among the biggest drivers of consumer price increases in April was the category for used cars and trucks, which rose a whopping 10% from the previous month. That was the largest month-over-month spike since the federal government began keeping track in 1953. Yet this spike is less reflective of broad-based trends in inflation than factors unique to the car market.
A global chip shortage has slowed down production of new vehicles, fueling demand for used ones. Rental car agencies also sold off much of their fleets last year, when covid shutdowns curtailed travel and these companies needed cash. Now that tourism is recovering, companies are desperate to restock their fleets and are bidding up prices on used cars. Eventually, those fleets will be restocked, and other supply chain issues should unwind.
Prices have also spiked for building materials, such as lumber. Over the past year, pandemic-driven demand for housing surged; that new demand (plus unhelpful tariffs, imposed by Donald Trump and left in place by Biden) left lumber in short supply, at least in the near term. So prices have risen. As lumber mills ramp up production, some of those price pressures should abate.
Other pandemic-sensitive areas of the economy, such as airline fares and hotel room rates, also recorded big gains year over year — but that’s mostly a reversal of the steep discounts on offer during the early days of the COVID outbreak.
Then there are gas prices. In recent days, fuel prices have spiked, but that’s clearly linked to a cyberattack that shut down a major East Coast pipeline.
Customers panic-hoarded gas, jacking up prices further, much like what happened a year ago with toilet paper. The pipeline has restarted operations, and conditions should eventually normalize. This saga tells us little about underlying inflationary forces in the economy.
The Federal Reserve and other economic analysts are clearly hoping that these various bottlenecks and reopening pains clear soon, and that currently constrained production soon meets the level of goods and services that customers are demanding.
If output expands, that means we get solid economic growth. That’s good! It’s exactly what we want as the economy heals. If, instead, businesses have trouble adequately ramping up — maybe because unemployed workers remain reluctant to return to jobs, or supply chains remain stuck — then more dollars are left chasing the same amount of goods and services. In that case, we’re more likely to face sustained inflation and overheating.
That’s not so good. Particularly since the Fed would likely intervene to stamp out rising prices, which historically has resulted in slower growth or even recession.
It’s just not clear yet which state of the world we’re in; as I said, there are reasons to be optimistic. One possible wild card is whether regular people’s expectations about inflation change. If everyone interprets recent price spikes as temporary shocks that will disappear as the economy reopens and production ramps up, then inflation and overheating concerns should fade. But if people start to freak out about inflation, then inflation becomes a self-fulfilling prophecy. Businesses start preemptively raising prices and wages, because they expect everyone else to do so, too.
Yes, consumer surveys and financial markets suggest inflation expectations are up, but not distressingly so. So, for now, overheating fears may be a little overheated.