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American inflation: global phenomenon or homegrown headache?

Editor’s note: On November 22nd, after this article was published, the White House said it would nominate Jerome Powell to a second term at the Federal Reserve THE FRISSON of relief among some of America’s most outspoken left-leaning economists is unmistakable. Whenever other countries report high inflation figures, they seize on it as evidence that America’s own bout of price rises is part of a global trend. “I hate to ruin the victory lap of all the people boasting that Biden’s Recovery Act would be inflationary, but the UK also had a big jump in inflation, with no big stimulus,” tweeted Dean Baker of the Centre for Economic and Policy Research, a think-tank, on November 17th. A few days earlier Paul Krugman, a Nobel-prizewinning economist, made a similar comparison between Europe and America. “What’s happening in the United States isn’t mainly about policy,” he concluded. That argument, if correct, matters a great deal. The implication would be that inflation is largely out of the hands of American officials. Like their counterparts elsewhere, they are hostage to the pandemic-blighted global economy. Central bankers, in this view, should be cautious about increasing interest rates, because that would do nothing to boost production, the nub of today’s problems. Are these economists right? Is America’s inflation, now running at its fastest in three decades, global or homegrown? The case for the former is straightforward. Most rich countries, from Britain to Australia, face similar price pressures. One common denominator is snarled supply chains, which have made everything from cars to furniture scarcer and dearer. Another commonality is the pandemic’s lingering impact on the labour market. On November 19th Christine Lagarde, the head of the European Central Bank, said that higher services prices reflect job vacancies in contact-intensive workplaces such as restaurants. The diagnosis applies just as well to America. Simply put, life is not yet back to normal, and inflation is a symptom. This global perspective is unquestionably important. Yet it is insufficient: inflation is now higher in America than in any other advanced economy, by some distance. The clearest comparison is to look at prices today and those 24 months ago, to iron out data distortions from the pandemic. On this basis, consumer prices are up by about 8% in America, twice as fast as in the euro area. The case that this is at least partly homemade points to America’s unusually forceful pro-growth policies throughout the pandemic. Over the course of 2020 and 2021 America’s fiscal deficit is on track to average about 14% of GDP, according to the Congressional Budget Office. That is higher than in any other G7 country. The Federal Reserve has also stood out for its ultra-loose policies, such as its bond-buying. The assets on the Fed’s balance-sheet have doubled over the past two years as a share of GDP. This month the Fed started to pare back bond purchases, but financial conditions remain loose, with real interest rates in negative territory. The remarkable degree of stimulus helps explain the boom in American retail sales. There is no doubt that the pandemic has shifted consumption from services towards goods. Yet even allowing for this distortion, the American data are jaw-dropping. In the second quarter of 2021 spending on durable goods was roughly a third higher than in the final quarter of 2019, far outpacing the increases in other big economies (see chart 2). Indeed, buoyant American demand may well have exacerbated global shortages and spilled over into higher inflation elsewhere. Consider maritime shipments. Port throughput in America was 14% higher in the second quarter of 2021 than in 2019. Other parts of the world have been more subdued: throughput in Europe was 1% lower. But shipping rates everywhere have soared as capacity has been diverted to transpacific trade. Recognising that inflation in America stems in part from its stimulus does not mean that those policies were bad. They catalysed its vigorous economic rebound and its rapid drop in unemployment. Yet as time goes on, the inflationary dangers have become apparent. If ultra-loose policies helped cause inflation, tighter policies ought to figure in the solution. The Fed is gradually moving in that direction. On November 19th two of its governors, Richard Clarida and Christopher Waller, speaking at separate events, said that the central bank’s next meeting in December may include a discussion on whether to scale back its monthly asset purchases more swiftly. That, in turn, could clear the path for interest-rate increases in the first half of 2022. President Joe Biden, for his part, has adjusted his tone on inflation. As recently as July he described the jump in prices as temporary, a by-product of the pandemic. In recent weeks he has instead been forthright in saying how much inflation hurts Americans and declaring that “reversing this trend is a top priority”. What can the president do to lower prices? Some of his actions have been more performative than substantive. On November 23rd Mr Biden announced that America would release 50m barrels of oil from a national strategic stockpile, in a bid to lower prices at the pump. But that is not enough to truly move the needle. On November 9th the White House announced an “action plan” to expand port capacity, but that could take years to bear fruit. Mr Biden could remove tariffs on Chinese products to help lower import prices. Yet that could be construed as a win for China, politically untenable in America these days. In one respect, however, Mr Biden has done the right thing, if only by default. As his pandemic stimulus expires, fiscal policy is naturally getting stingier. The Hutchins Centre, a think-tank, calculates that this tightening could lop about two percentage points off America’s growth rate next year. Critics have argued that an ambitious social-spending and climate package—the cornerstone of Mr Biden’s agenda, currently wending its way through Congress—would add to inflationary pressures. But its investments will be spread out over a decade, adding up to less than 1% of GDP each year. That will deliver only a modest upfront kick to growth and have a negligible impact on prices. “My landmark legislation is relatively insignificant in the near term” would not make for a great political slogan. But after 18 months of big government spending, it is just what the American economy needs. ■ Clarification: Since this article was first published, chart 1 has been amended to include more countries and to show covid-related fiscal measures instead of the fiscal deficit. For more coverage of Joe Biden’s presidency, visit our dedicated hub and follow along as we track shifts in his approval rating. For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.

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