The federal response due to the coronavirus health crisis caused an extra liquidity in the system and the monetary base is expanding at record levels. As a consequence, economists agree that inflation may rise up to 5.5% at the end of 2021 but are still uncertain what levels it will reach by 2022 and what policies the Federal Reserve Bank will take.
“It seems inflation might be transitory but we don’t have enough information yet to conclude, says Miguel Iraola, Ph.D. professor of economics at the University of Miami. “There is a trend of high inflation, especially after January 2021, and the question is whether these trends of inflation are going to continue going up, or if we are going to reach a new point in which inflation will converge back to this 2% that is the target for the central bank.”
A Federal Reserve press release June 17 said the economy’s path will depend “significantly on the course of the virus… and the committee will aim to achieve inflation moderately above 2% for some time.” But some argue that the inflation may reach 4% to 5.5% by year’s end.
“Businesses and people are aware that the level of prices is going up to 4% and in that sense, people are vigilant about what might happen,” says Tony Villamil, president of economics consulting firm Washington Economics Group Inc. “It’s a wait-and-see attitude and at this stage I haven’t seen businesses rushing to change their price levels even though we are beginning to notice that in some areas.”
Manuel Lasaga, president and co-founder of economics and finance consulting firm StratInfo, foresees that inflation might go as high as 5.5% at the end of the year.
“I think that it might not be completely perceived yet, but as we continue to see high monthly inflation numbers, I think that by the end of the year we will still be around 5% and 5.5% inflation,” says Mr. Lasaga. “At this point of the year, there is nothing the Federal Reserve can do. But depending on the response for next year, we might see if inflation levels will continue rising or if they will go back to the target of 2%. Depending on how the Fed handles this and the federal government’s response in terms of spending, this inflation could be temporary. The size of the physical spending just was too much for the economy to digest without inflation, so this is what we are going through now. Eventually the markets will begin to act and will begin to meet higher inflation needs. Interest will have to go up and once that happens, as an example, as the 10-year treasury bond rises, that is probably the key pricing interest rate for every single mortgage, mortgage rates are going to go up, and therefore it’s likely to cool demand.”
But there are other factors to take into account.
“Another important element is the expectation of future inflation,” Professor Iraola argued. “What are the expectations for companies and for households? Those expectations come in part for the reputation of the central bank. In this case, the Federal Reserve Bank has a reputation of being able to maintain inflation under control.”
“If the Federal Reserve puts on the brakes too hard, then rates could go so high that we would go down into another recession,” Mr. Lasaga added. ”So, I think that at this point the decision-makers, the Fed, the US government spending and the budget are going to kind of take it one day at a time.”
“There are two things the Federal Reserve could do, although it is still not clear what path it will take,” Mr. Villamil argued. “One is to stop the asset-buying program, which is close to a trillion a year in terms of buying assets and therefore creating money by buying those assets. The second is to raise the federal funds rate, which is a signal of a tightening monetary policy by probably 1% to 2% by the end of 2022. There are a few things businesses could do to protect themselves. They should keep their business plans related to what happens down the road, especially if the Fed begins to tighten and the economy slows. Keep your inventories lean in relation to your needs. It is a wait-and-see attitude but you have to be ready for the possibility that the Feds will have to tighten policy next year.”
As for citizens, Mr. Villamil recommends taking advantage of low interest rates.
“Refinance assets as much as you can,” says Mr. Villamil. “This is the time to do it before the rates change… Consumers should be aware that prices are going up and they need to be aware that this may or may not be temporary, so they want to make sure to adjust their purchases accordingly, and it is very important for the typical person to make sure you are OK at your job.”
The three economists agree that the recession we are facing as a result of the pandemic is something never experienced before in our living memory, so we are still exploring an uncertain territory.
Source: Miami Today