What "transitory" means and why it matters

Inflation is bad, but it is much more likely to go down than up.

Everyone’s got inflation on the brain these days, and I’m detecting a growing impatience with reassurances from authorities that rising prices are likely to be “transitory.” At the same time, analysts who earlier in the year proclaimed themselves Team Transitory have generally been taking victory laps as they feel data tends to support their view.

I think that kind of team thinking makes for unhealthy analysis, and at this point in time, it’s useful to draw a distinction between two claims.

  • Inflation in the back half of 2021 has been higher than the Fed forecasted it would be at the beginning of the year, and it’s now overwhelmingly likely that we’ll be experiencing some high inflation in the first half of 2022.

  • There is no sign as of yet of inflation accelerating or becoming embedded in expectations in a way that would suggest a possible loss of control over price rises.

The former is a legitimate beef that the public has with policymakers. A non-trivial number of analysts warned of this possibility, and they are correct to feel vindicated. In particular, the inflation that we have seen has not been limited to a handful of pandemic-specific sectors of the economy and instead now pretty clearly reflects a broad-based increase in cash induced by very generous fiscal policy.

But on the other hand, the “transitory” proposition never really hinged on this.

A huge global pandemic is a really big deal. It’s killed hundreds of thousands of Americans, many more people around the globe, and it’s also led to many cases of non-fatal illness that were nonetheless serious and involved hospitalizations or prolonged recuperation at home. The pandemic has also significantly altered almost everyone’s daily conduct — not commuting to offices, wearing masks on the job, conferences and conventions going global, schools getting stricter about attendance while sick. An economic cost alongside the humanitarian one is inevitable; there’s nothing fiscal or monetary policy can do about that. What policy can do is impact what kind of cost is ultimately borne.

In the beginning, it seemed like the pandemic would induce a really serious recession. But thanks to Jerome Powell and Steve Mnuchin and Nancy Pelosi and Joe Biden and Raphael Warnock and others, that hasn’t been the case — we pumped a ton of money into the system, flushed people’s pockets with cash, and largely averted severe economic deprivation despite a very scary and disruptive virus. Instead, we got a moderate amount of inflation, which while bad is clearly preferable to a prolonged spell of mass unemployment. So why don’t policymakers always opt for “moderate amount of inflation” over “prolonged spell of mass unemployment?”

A big reason is that they worry that even a moderate amount of inflation could unleash an inflationary spiral of 5% this year, 6% the next, and 8% the year after that. And in this sense, inflation still looks clearly transitory.

We do not see a frenzy of consumption

Something that I think is pretty obvious but not always explicitly discussed is that perceptions of future price trends impact consumer behavior.

For example, Apple just released a series of new MacBook Pro laptops with new M1 Pro chips that look really good but are also pricey. As the owner of a MacBook Air with a now-outdated M1 chip, I am kind of jealous of the owners of these new machines. And while they are expensive, I could afford to go buy a new one if I really wanted to. But I’m not going to do that, because one thing we all know about the computer industry is that improvement in quality is fairly rapid, and 18 months from now cheaper and/or better Mac laptops will likely be available. My current laptop is still very good, and it’s more prudent to wait.

But sometimes the market for a good isn’t like that. If you see a pair of sunglasses that you really like and you can afford to buy them, then you might as well buy them now. You could be thrifty and decide you actually don’t want to spend money on sunglasses, but there’s no particular reason to expect future sunglasses to be better or cheaper than current sunglasses. You just have to decide if your budget can accommodate them and how much you like them.

Rising prices, at least in theory, could have the effect of inducing current consumption.

If some kind of price wizard told me that Moore’s Law has been repealed and laptop prices will be higher in 2023 than in 2021 with no improvements in quality, then I might run out and buy a new MacBook Pro today. After all, why wait if the prices are going up? That’s the inflationary spiral, a dynamic in which nobody wants to hold onto cash because they perceive that its value is falling, so they spend, spend, spend right away. That furious pace of spending induces more inflation, which induces more spending. And the thing policymakers fear is that once that mentality has taken hold, it’s hard to break short of inducing an intense recession like we saw in 1981-82 when unemployment started at 7.4% on Ronald Reagan’s inauguration day and soared to 10.8% by November 1982.

The core claim of “transitory” is that this is not happening.

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