fbpx
December 3, 2021 Reading Time: 3 minutes

For the past few months, Federal Reserve Chair Jerome Powell has assured markets that high inflation would be temporary, as prices would naturally fall once supply constraints ease up. Testifying before the Senate Committee on Banking, Housing, and Urban Affairs on November 30, he reiterated this view. However, he also signaled that the Fed would take steps to rein in inflation. 

“We are committed to our price-stability goal,” Powell said. “We will use our tools […] to prevent higher inflation from becoming entrenched.”

Markets got the message. “He’s ready to shift the Fed into inflation-fighting mode,” Bloomberg’s Brian Chappatta reported. The five-year breakeven inflation rate, which peaked at 3.17 percent on November 15, declined from 2.91 percent on November 29 to 2.70 percent on December 1. 

Powell’s pivot is perhaps not surprising. President Biden nominated Powell to serve another term as Fed Chair on November 22, relaxing the political constraint Powell appears to have been facing. And the latest release from the Bureau of Economic Analysis confirms that inflation has continued to rise.

The personal consumption expenditures price index (PCEPI), which is the Fed’s preferred measure, grew 5.0 percent from October 2020 to October 2021––60 basis points faster than the year-on-year growth observed in September prior. On Tuesday, Powell acknowledged that “overall inflation is running well above [the Fed’s] 2 percent longer-run goal.” Inflation has averaged roughly 3.22 percent per year since January 2020.

The PCEPI and a 2-percent growth path projected from January 2021 are presented in Figure 1. While the high year-on-year inflation rate partly reflects that the price level was well below the 2-percent growth path last year, that is far from the whole story. If the price level had merely grown at 2 percent since January 2021, it would stand at just 103.5 today. In fact, it is 105.8. The price level, in other words, is 2.3 percentage points above the 2-percent growth.

Figure 1. Personal Consumption Expenditures Chain-type Price Index, January 2020-October 2021

While Powell indicated the Fed is prepared to act to bring down inflation, he was vague about how quickly and how far it can be expected to fall. “Most forecasters, including at the Fed, continue to expect that inflation will move down significantly over the next year,” Powell said.

Perhaps most surprisingly, Powell recommended ditching the term transitory. “We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation,” he told the Senate Committee. “I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”

I noted back in October that the word transitory invites confusion

The claim that we are experiencing transitory inflation at present might merely denote that the rate of inflation will eventually return to a more typical rate—something in the neighborhood of 2 percent. In this case, the price level will remain elevated and, correspondingly, the purchasing power of the dollar will remain depressed relative to what was likely expected prior to the deviation.

However, the claim is sometimes used to suggest much more: that the rise in prices will not be permanent. In this case, the rate of inflation will decline not merely to 2 percent, but rather to some rate below 2 percent for a period of time, in order to bring the price level back down to where it would have been had the deviation never occurred.

The latter would appear to be more in line with average inflation targeting, which the Fed committed to in August 2020. But others have pointed to statements from Fed officials indicating that they appear to have a flexible average inflation target in mind. A flexible average inflation target would allow the price level to remain elevated so long as the 2 percent rate is restored.

My own view is that the rate of inflation will eventually fall to roughly 2 percent, with the price level remaining well above where it would have been in the absence of the pandemic and corresponding policy response. I do not think this is consistent with the Federal Reserve’s Statement on Longer-Run Goals and Monetary Policy Strategy. But it would not be the first time the Fed has failed to keep its promise.

William J. Luther

William J. Luther

William J. Luther is the Director of AIER’s Sound Money Project and an Associate Professor of Economics at Florida Atlantic University. His research focuses primarily on questions of currency acceptance. He has published articles in leading scholarly journals, including Journal of Economic Behavior & Organization, Economic Inquiry, Journal of Institutional Economics, Public Choice, and Quarterly Review of Economics and Finance. His popular writings have appeared in The Economist, Forbes, and U.S. News & World Report. His work has been featured by major media outlets, including NPR, Wall Street Journal, The Guardian, TIME Magazine, National Review, Fox Nation, and VICE News.

Luther earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Capital University. He was an AIER Summer Fellowship Program participant in 2010 and 2011.

 

Selected Publications

Cash, Crime, and Cryptocurrencies.” Co-authored with Joshua R. Hendrickson. The Quarterly Review of Economics and Finance (Forthcoming).

Central Bank Independence and the Federal Reserve’s New Operating Regime.” Co-authored with Jerry L. Jordan. Quarterly Review of Economics and Finance (May 2022).

The Federal Reserve’s Response to the COVID-19 Contraction: An Initial Appraisal.” Co-authored with Nicolas Cachanosky, Bryan Cutsinger, Thomas L. Hogan, and Alexander W. Salter. Southern Economic Journal (March 2021).

Is Bitcoin Money? And What That Means.”Co-authored with Peter K. Hazlett. Quarterly Review of Economics and Finance (August 2020).

Is Bitcoin a Decentralized Payment Mechanism?” Co-authored with Sean Stein Smith. Journal of Institutional Economics (March 2020).

Endogenous Matching and Money with Random Consumption Preferences.” Co-authored with Thomas L. Hogan. B.E. Journal of Theoretical Economics (June 2019).

Adaptation and Central Banking.” Co-authored with Alexander W. Salter. Public Choice (January 2019).

Getting Off the Ground: The Case of Bitcoin.Journal of Institutional Economics (2019).

Banning Bitcoin.” Co-authored with Joshua R. Hendrickson. Journal of Economic Behavior & Organization (2017).

Bitcoin and the Bailout.” Co-authored with Alexander W. Salter. Quarterly Review of Economics and Finance (2017).

The Political Economy of Bitcoin.” Co-authored with Joshua R. Hendrickson and Thomas L. Hogan. Economic Inquiry (2016).

Cryptocurrencies, Network Effects, and Switching Costs.Contemporary Economic Policy (2016).

Positively Valued Fiat Money after the Sovereign Disappears: The Case of Somalia.” Co-authored with Lawrence H. White. Review of Behavioral Economics (2016).

The Monetary Mechanism of Stateless Somalia.Public Choice (2015).

 

Books by William J. Luther

Get notified of new articles from William J. Luther and AIER.
AIER - American Institute for Economic Research

250 Division Street | PO Box 1000
Great Barrington, MA 01230-1000

Contact AIER
Telephone: 1-888-528-1216 | Fax: 1-413-528-0103

Press and other media outlets contact
888-528-1216
[email protected]

Editorial Policy

This work is licensed under a 
Creative Commons Attribution 4.0 International License,
except where copyright is otherwise reserved.

© 2021 American Institute for Economic Research
Privacy Policy

AIER is a 501(c)(3) Nonprofit
registered in the US under EIN: 04-2121305