Infection of Inflation Already Here for Things We Need to Buy

While economists may be relieved the laws of supply and demand are still working at a juncture in our society when so many textbook rules about economic discipline are in doubt, the fact that the price of goods that we purchase has been soaring far beyond the yearly inflation rate of 1.3%, while the price of stuff we’re no longer focused upon acquiring has been falling, is definitely pause for concern.

Nobody has made that point better than the Wall Street Journal, which over the weekend wrote that "Inflation Is Already Here—For the Stuff You Actually Want to Buy."

As the WSJ's James Mackintosh writes, "if it feels like the price of everything you buy has been soaring, that’s because it has—even as central bankers everywhere worry about the danger of deflation.

Which makes sense, of course:  with more demand for a given good or service, the price will jump and vice versa. And as the data reveals, in this post-Covid, "work-from-home" age, annual inflation for certain products is now solidly overshooting the Fed's targets:

Start with the cost of food at home, where so many Americans have been spending their time, and which was up 4.6% in August compared with a year earlier, the biggest rise in almost a decade. Meanwhile, in deserted workplace and school cafeterias, food is 3% cheaper.

While food prices are traditionally volatile, the same pattern emerges for many things sensitive to us sitting at home on Zoom. Few home workers need a new suit or dress (down 17%), makeup (down 3%), hotel room (down 13%) or air ticket (down 23%).

At the same, the following activities have led to sharp price increases: sitting at home in your pajamas (men’s nightwear is up 4%), cycling (bikes up 6%), reading for pleasure (books up 4%, newspapers up 5%) and making things (sewing machines and fabric up 9%, cameras up 4%). Medical care is in demand (up 5%), while higher education is much less attractive (tuition fees up 1.3%, the lowest since data started in the late 1970s)

The swings in buying habits have also accentuated a core aspect of the current inflation/deflation debate: namely, how inflation is officially measured, with an emphasis on the difference between the consumer-price index (CPI) and the personal-consumption-expenditures price index (PCE). As the WSJ reminds us, CPI captures the headlines and determines the return on inflation-linked Treasuries, or TIPS. The Federal Reserve uses PCE—and the two diverged over the summer.

CPI is assessed based on spending patterns from a couple of years ago, while PCE recalculates spending every month. The latest PCE data is only through July, but showed prices rebounded, rising 0.4% over three months compared with the prior three months, on an annualized basis. CPI was still showing prices falling on that basis, although in August the reopening of the economy pushed three-month annualized CPI inflation above 3%.

Many of these concerns will be laid to rest if and when Congress agrees on a fifth fiscal stimulus - once Pelosi and McConnell agree on another $1.5-$2 trillion in stimulus and is handed out to US consumers, this summer’s price rises could continue and become a serious worry for investors. Alternatively, if the second wave of Covid-19 is followed by a third, heavy job losses and renewed recession would threaten demand and thus prices again. In Europe, the three-month inflation rate fell back to exactly zero in August as a second wave hit Spain and France.

The bottom line is that while many debate what happens next, the current reality is stark: surging prices for things Americans needs, offset by declining prices for things they don't. This, according to the Fed, washes out and does not merit tighter financial conditions, even though for the average American on Main Street, the ongoing price spike has proven to be especially painful.