Nobody Likes to Pay More for Stuff. So Why Does The Fed?

Most folks on Wall Street agree prices for all sorts of things are moving higher, both at the goods level (think corn, oil, copper, houses, used cars) and at the broad basket level (think the Consumer Price Index). Now, given the shutting down of the economy last year, and the subsequent collapse in demand and prices, the year-on-year comparisons into 2021 pretty much guaranteed a dramatic jump in prices as the economy reopened; stressed supply chains are adding to inflationary pressures. 

The more consequential conversation on Wall Street is around whether the jump in prices is transitory – as the Fed believes, which would justify an accommodative monetary policy – or structural, which would compel the Fed to taper bond purchases and raise rates sooner rather than later. And truth be told, we don’t yet know. In the meantime, two other questions worth considering are 1) Why the Fed wants to see prices move higher? And 2) Why the Fed wants to hit its 2%+ inflation target? I mean, who wants to pay more for stuff? 

On that front, we think any economy works best with a bit of consistent inflation and is at great risk when prices for goods and services decline persistently year-on-year. Consider, if you know that the price of a house will decline a few percentage points year-on-year, you will wait to purchase that home (if you ever purchase it at all – who wants to buy an asset that goes down in value?). And as a society becomes accustomed to prices declining year-on-year, economic growth can be hard to come by. We saw persistent deflation (the opposite of inflation) during the Great Depression and for most of the past 30 years in Japan.  

A bit of inflation spurs investment and economic activity and makes any debt taken on to purchase an asset more manageable. The Fed is right to want a bit of inflation; the risk today is that they end up getting more than they bargained for. 

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Tagged: Tim Holland, weekly wire, market perspectives, U.S. economic growth