The inflation numbers for April released on Wednesday show the Consumer Price Index rising by 4.2% compared to April 2020, higher than the Bloomberg consensus forecast of 3.6%.
Yes, prices are increasing. But that’s a good sign that demand is growing again.
The core CPI, which excludes the volatile food and energy components, rose 3.0%, up from the 1.6% year-over-year rate of increase in March.
This marks the first time since the recovery from the Great Recession that the inflation rate has been greater than 3% on a year-over-year basis. The onset of the pandemic brought about some abnormalities in purchasing behavior that have created the conditions for the sharp rise in the CPI, also known as the base effects.
Take the costs associated with getting around in a car. After bottoming out during the lockdown last year, gasoline prices pushed higher from December through March. In addition, the price of used cars and trucks increased by 10% from March to April, the largest one-month increase since the series began in 1953. That alone accounted for more than a third of the seasonally adjusted all-items increase in the CPI.
Even with these base effects, there will undoubtedly be calls for the Federal Reserve to reverse its accommodative monetary policy. At the same time, the debate over additional fiscal stimulus programs will turn to inflation and rising interest rates as reasons for policymakers not to accumulate still more debt.
The Federal Open Market Committee has already cited the need for the economy to overshoot the Fed’s 2% inflation target to meet one part of the Fed’s dual mandate, full employment.
With respect to the second part of that mandate, price stability, Fed Chairman Jerome Powell has been explicit in communicating that the data for the next few months must be interpreted through the lens of the base effects, which should begin to recede as the recovery continues. This is what Powell and other Fed speakers mean when they say that inflation data is likely to be transitory.
Because of the pandemic’s shock, there were limited opportunities for consumers to spend or travel last year. Instead, most households limited purchases to essential items, reserving a disproportionate amount of their income as precautionary savings. This lack of demand led to a general decline in prices, particularly for energy, travel, and leisure and hospitality services.
Compared to pre-pandemic prices in February 2020, the Consumer Price Index in April has increased by 3.1%, an increase that is well within the desired range for an economy that has not yet closed the output gap and is a long way from closing the employment gap.
So comparing prices in today’s marketplace to prices 12 months ago is an apples-to-oranges comparison. We show this in the analysis below, which assumes what would have been a normal trajectory for consumer prices had the pandemic not occurred. We are assuming that prices would have continued growing at the 12-month average rate of 2% per year as of February 2020 (for example, a 0.17% compounded monthly rate).
Yes, prices are increasing. But that’s a good sign that demand is growing again and that the recovery is gaining steam.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.