Is Inflation Transitory or Not?


Inflation is a hot topic, and not just within the financial media. If you’ve made a trip to the gas station recently, you’re acutely aware of rising prices. It’s also required, as a new part of our social contract, to react with amazement at any mention of home or car prices in casual conversation.

I cringe at calling 2020 “extraordinary” simply because it’s a word most often associated with positive things. Yet, it was. We saw the first-ever coordinated shutdown of the entire world, which would at least create temporary effects on its economies. Inflation is one of those effects.

How long should we expect inflation to continue?

In June, Jerome Powell, the Chairman of the Federal Reserve, announced that the inflation we’re currently experiencing is “transitory”, only to hedge his claims a month later. Yet, a fierce debate over its transitory nature existed months before Powell galvanized it by uttering the t-word.

It’s a debate where we all have a vested interest. Let’s examine each argument and its implications.

The Case for Transitory Inflation

Given so much has changed over the last 18 months, it’s reasonable to expect that the economy would suffer some after-effects during its recovery. Indeed, most of the arguments for transitory inflation center around life finding a post-pandemic steady-state. Let’s examine them.

Argument 1: Pent-Up Demand Will Normalize

For those who believe inflation is transitory, the pandemic and subsequent lockdowns created “pent-up demand” that was released when the world reopened. They reason that this demand will eventually normalize. Remember, as demand rises, so do prices.

Indeed, much of the current spike in the Consumer Price Index (CPI) is due to hotel prices, airfares, and dining out — all things that people desperately wanted after the lockdowns ended.

Argument 2: Commodities Pricing is Temporary

Commodity prices, such as copper and lumber, have jumped as part of the shift in housing we experienced in 2020. As one of the main price drivers of this boom, lumber prices were so extreme that they found themselves in meme territory.

Lumber Pricing Meme

Without question, the housing market was upended by the pandemic and subsequent working-from-home fallout. As this shift stabilizes, the demand for housing should abate and prices should fall.

Argument 3: Supply Chain Disruptions Will Normalize

Factory shutdowns and global shipping bottlenecks created shortages of certain items (such as semiconductor chips) that reduced supply, driving prices higher. As global trade was halted, orders for critical components of durable goods were delayed or canceled. Once things return to normal, trade should resume and these inflationary forces should recede.

Argument 4: The World is Opening Back Up

Global trade and competition are inherently deflationary; think about the price of flat-screen TVs over the years as an example of this. Now that the world has reopened, factories are back online, and trade is starting to flow again, we can expect deflationary pressures on prices.

Unfortunately, an increase in infections due to the Delta variant may spell trouble for this argument. We’ll see.

A transitory spike in inflation is the best-case scenario for the economy. It’s hard to imagine any way this current spike in inflation could have been avoided after the pandemic. If this upward pressure on prices eventually eases, then we stand a better chance of returning to a healthy economy over the long term.

The Case for Non-Transitory Inflation

While the case for transitory inflation is strong, it’s not iron-clad. Critics of Powell and the Fed (of which there are many), present their own arguments why inflation will plague us into the foreseeable future.

Argument 1: Monetary Expansion

The stupefying amount of stimulus created over the last year would inevitably cause some level of inflation. Years ago, the renowned economist Milton Friedman claimed that inflation is strictly a monetary phenomenon. Essentially, the more money you print, the more inflation you get. Hence, inflation is not transitory.

We’ve certainly been printing money.

The Fed will unlikely shrink the money supply in the near future, supporting the idea that inflation will be with us for a while.

Argument 2: Wage Growth

All of this stimulus created second-order effects that further exacerbate inflation. The labor market is a fantastic example. As workers collect enhanced unemployment benefits, the government creates a disincentive to work in some circumstances. (I’m not arguing that these benefits weren’t good or needed. I’m simply pointing out some of the economic effects.)

There’s plenty of evidence of this in the employment data and based upon the amount of “help wanted” signs at restaurants and retail establishments. Anecdotally, the business owners I’ve questioned about labor shortages have almost unanimously confirmed it’s a massive problem. They just can’t find help right now.

In order to find and retain employees, they must offer signing bonuses and higher pay. Once employees’ wages are increased, it becomes awfully difficult for employers to lower wages once things get back to normal. Of course, these increased costs will eventually be passed along to customers and clients.

Argument 3: Housing Price Effects Have Lagged

The “inflation is non-transitory” crowd also argues that housing price increases have not yet been reflected in the CPI data. These costs, known as owner’s equivalent rent will start being reflected in CPI calculations later in 2021 due to the lag in reporting. We all know that housing prices have gone geosynchronous over the last year. It’s only a matter of time before they’re reflected in headline inflation.

Argument 4: Germophobes Are Expensive

The costs of PPE, cleaning supplies, and the additional labor required to implement COVID sanitizing protocols will eventually be passed along to consumers as well. Sectors like travel, events, and restaurants will all experience higher costs in order to protect customers going forward.

Closing Thoughts

The arguments for each case are compelling, but it’s too early to say definitively that we’ll see transitory inflation or not. It’s important to remember that the Fed has a vested interest in keeping the economy on its feet. They just can’t come out and say that we’re going to have oodles of inflation going forward. That would spook markets and likely cause a jump in interest rates.

A case can be made for future deflation as well. There is some debate on whether or not some aspects of monetary stimulus are actually making their way into the economy. So, while the current conversation is focused on whether or not we’ll have some inflation or lots of it, there are other potential outcomes. It’s important to remain flexible.

If you need help preparing for transitory (or non-transitory) inflation, click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.

As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
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