The shockingly high inflation figures released by the government on Wednesday demonstrate once again how little we understand what makes prices rise (and sometimes fall).
By “we,” I mean everyone, including officials at the Federal Reserve, who are trying, but not entirely successfully, to bring inflation back to their 2% annual rate.
“As is often the case, we are navigating by the stars under cloudy skies,” Federal Reserve Chairman Jerome Powell said at the annual monetary policy conference in Jackson Hole, Wyoming, in August.
The U.S. Bureau of Labor Statistics reported Wednesday that the consumer price index rose 0.4% in March from February, beating the 0.3% expected by many economists. The monthly core inflation rate, which excludes volatile food and energy prices, was also 0.4%. The all-item index rose 3.5% over the past year.
Each inflation report provides new fodder for debate between economists who worry that inflation will remain well above the Fed’s target and those who expect inflation to soon return to a downward trend.
David Rosenberg, president of Toronto-based Rosenberg Research, said nervous investors may be overreacting to Wednesday’s data. “This report shows many signs of deflation where it matters – in demand-sensitive areas,” he wrote in a note to clients. He noted that prices for sporting goods, toys, electronics and cars fell in March.
Monthly data always contains a lot of noise. In the long run, the mystery is not why inflation is high, but rather the opposite: why inflation has fallen so sharply from its pandemic peak even though the labor market remains tight. It is. Conventional wisdom holds that when there is a shortage of workers, workers use their bargaining power to demand higher wages, which increases inflation. That didn’t happen often.
Selvers Strom, a senior lecturer in economics at the Delft University of Technology in the Netherlands, wrote this week in an article for the Institute for New Economic Thinking that the movement of inflation is an important part of traditional New Keynesian theories about why prices rise and fall. I wrote that my trust was being shaken.
Strom writes that central bankers like Powell are “clear that standard macro models have little use in the current macroeconomic environment.”
That’s a strong argument — perhaps too strong — but it fits perfectly into Powell’s Jackson Hole metaphor of navigating by the stars under cloudy skies. Inflation remains poorly understood.
