William Luther at AIER asks “Is Inflation Merely Catching Up?“:
…it is simply not the case that the observed inflation has merely been what was required for catching up. The price level today is greater than what it was expected to be in the absence of a pandemic and what the Fed implicitly said it would be given its two-percent inflation target. The price level has more than caught up with expectations. The question, now, is whether it will continue to grow so rapidly, remain elevated, or subside.
In other words, his answer to the question posed in the title is “no”. Whether it has pernicious effects depends on how persistent inflation is relative to expected.
I have graphed the data for the PCE price index, the Cleveland Fed’s nowcast as of 7/26, and WSJ July forecast against the 2015M01-2021M01 trend Dr. Luther cites, as well as the 2% trend.
Figure 1: Personal Consumption Expenditure (PCE) price deflator (black), Cleveland Fed nowcast (gray line), WSJ survey mean (teal line), 2015M01-20M01 trend (light blue), 2% trend from 2020M01 (pink), all 2012=100, on log scale. Source: BEA, Cleveland Fed (accessed 7/26), WSJ July survey, and author’s calculations.
Using Dr. Luther’s trend it seems clear that the PCE price index has overshot as of today, if the Cleveland Fed’s nowcasts are accepted. With inflation persistently higher than 2% (as indicated in the WSJ’s July survey of economists), then the price level continues to diverge from trend.
As of July, the price level would be 1.3% above trend; and 1.5% by November 2023 (in log terms). Useful to compare with the fact that in April and May of 2020, the index was 1.2% below trend.
Back in January of 2012, Jeffry Frieden and I called for conditional inflation now! at 4%-6% for several years. That call (if for 2%) implies the following:
Figure 2: Personal Consumption Expenditure (PCE) price deflator (black), Cleveland Fed nowcast (gray line), WSJ survey mean (teal line), 2% trend from 2020M01 (pink), 2% trend from 2012M01 (red), all 2012=100, on log scale. Source: BEA, Cleveland Fed (accessed 7/26), WSJ July survey, and author’s calculations.
From that perspective, we have a lot of catching up to do. As of July, the price level would be 3.4% below trend; and 3.3% by November 2023.
Which one is the right comparison? Dr. Luther is right to interpret the shock as coming with the pandemic in early 2020. Moreover, Flexible Average Inflation Targeting (FAIT) can be dated as being effective in January 2020, so another reason to make that comparison. On the other hand, if we have been thinking trying to redress overly slow price inflation over the past decade in the wake of the Great Recession, then the calculations in Figure 2 are in some sense more appropriate.