An analysis of US inflation, and its potential trajetory; also, the impact on Indian economy
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America facing massive inflation - at 39 year high
- The story: The demon of inflation has returned in full blast. U.S. consumer prices rose strongly in November '21 as Americans paid more for food and a range of goods, leading to the largest annual gain since 1982. This may turn out to be a political challenge for President Joe Biden's government and the Federal Reserve may quickly start raising interest rates in 2022.
- Data: The report from the Labor Department, which followed on the heels of a slew of data in December showing a rapidly tightening labour market, makes it likely the U.S. central bank will announce that it is speeding up the wind-down of its massive bond purchases at its policy meeting. The Fed tracks the personal consumption expenditures (PCE) price index, excluding the volatile food and energy components, for its flexible 2% inflation target.
- With supply bottlenecks showing little sign of easing and companies raising wages as they compete for scarce workers, high inflation could persist well into 2022.
- The increased cost of living, the result of shortages caused by the relentless COVID-19 pandemic, is hurting Biden's approval rating.
- The White House and the Fed have characterized high inflation this year as transitory. Consumers may not buy that argument for long, and there's not much room to explain away this inflation from pandemic or reopening anomalies.
- Nature of inflation: Ultimately, inflation is a tax, gas and food are among the most regressive aspects of it. Lower-income Americans spend disproportionately on both.
- The consumer price index increased 0.8% in Nov'21, after surging 0.9% in October. The broad-based rise was led by gasoline prices, which increased 6.1%, matching October's gain. With crude oil prices declining recently, gasoline prices have likely peaked for now.
- Food prices rose 0.7%. The cost of food at home increased 0.8%, driven by a jump in the price of fruits and vegetables, meat, and cereals and bakery products. The price of food consumed at home gained 6.4% over the past 12 months, the most since December 2008.
- In the 12 months through November, the CPI accelerated 6.8%. That was the biggest year-on-year rise since June 1982 and followed a 6.2% advance in October. Economists polled by Reuters had forecast the CPI would climb 0.7% and rise 6.8% on a year-on-year basis.
- Rising inflation is eroding wage gains. Inflation-adjusted average weekly earnings fell 1.9% on a year-on-year basis in November '21.
- What President said: Joe Biden acknowledged the increased burden on household budgets from the high inflation, while trying to reassure Americans that the country was pushing ahead with efforts to ease supply bottlenecks. He said: "We are making progress on pandemic-related challenges to our supply chain which make it more expensive to get goods on shelves, and I expect more progress on that in the weeks ahead". since gasoline prices have been trending lower since the end of November, it helped lift consumer sentiment in early December.
- Investors took the strong inflation readings in stride. U.S. stocks were trading higher. The dollar (.DXY) slipped against a basket of currencies. U.S. Treasury prices rose.
- The government reported that the unemployment rate fell to a 21-month low of 4.2% in November. Tightening labour market conditions were underscored by a report on Thursday showing new applications for unemployment benefits dropped to the lowest level in more than 52 years last week.
- There were 11 million job openings at the end of October and Americans quit jobs at near-record rates. Fed Chair Jerome Powell has said the U.S. central bank should consider hastening the tapering of its bond purchases.
- More data: Excluding the volatile food and energy components, the CPI rose 0.5% last month after gaining 0.6% in October. The so-called core CPI was supported by rents, with owners' equivalent rent of primary residence, which is what a homeowner would receive from renting a home, rising a solid 0.4%. Prices for used cars and trucks increased 2.5% for a second straight month. New motor vehicle prices rose 1.1%, marking the eighth consecutive month of gains. A global semiconductor shortage has undercut motor vehicle production. Airline fares rebounded 4.7%. But gains are likely to be curbed by the spread of the Omicron variant of COVID-19, which could make some people hesitant to travel by air. The United States is already experiencing a resurgence in coronavirus infections, driven by the Delta variant.
- US inflation's impact on India: When prices increase globally, it will lead to higher imported inflation. Everything that India and Indians import will become costlier. High inflation in the advanced economies, especially the US, will force their central banks to abandon their loose monetary policy. A tight money policy in advanced economies would imply higher interest rates (A tight monetary policy involves increasing interest rates to constrain borrowing and to stimulate savings). That will affect the Indian economy in two broad ways - (i) Indian firms trying to raise money outside India will find it costlier to do so, and (ii) The RBI will have to align its monetary policy at home by raising interest rates domestically (That may further raise inflation because the production costs would go up).
- Summary: The so-called core CPI jumped 4.9% on a year-on-year basis, the largest rise since June 1991, after increasing 4.6% in October. The Fed tracks the personal consumption expenditures (PCE) price index, excluding the volatile food and energy components, for its flexible 2% inflation target. For Joe Biden, the political ropewalk just got slightly more complex.
- EXAM QUESTIONS: (1) Explain the nature of inflation management that US Fed undertakes. (2) What kind of a tax is inflation? Explain. (3) What is the differene between inflation in the US, and in India? How are the two related?
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