Inflation Returns

Post from First Trust Economics Blog

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

Nov. 15th 2021

Inflation is back and worse than it’s been in decades.

Consumer prices rose 0.9% in October and are up 6.2% in the

last twelve months. Two more months of moderate increases,

and the CPI will be 6.5% in 2021, the highest inflation since


As a result, after surging in the earliest stages of the

pandemic, “real” (inflation-adjusted) average hourly wages have

been trending downward since peaking in April 2020 and are

down 1.2% in the past year. In fact, real average hourly wages

are up only 1.5% since February 2020 (pre-COVID) versus a

gain of 2.3% in the twenty months before COVID arrived.

One of the Keynesian justifications for applying a very

loose monetary policy was to run the economy “hot,” in order to

offset damage from COVID itself and pandemic lockdowns. But

this has apparently backfired as inflation accelerated rapidly. It

looks like workers are the ones getting burned.

The Federal Reserve, however, says inflation is going to

drop next year. And we think the Fed is probably right about the

direction of inflation; prices should go up next year, but not as

fast as this year.

Why? Think of oil, for example, which ended last year at

$48 per barrel (for West Texas Intermediate) and closed on

Friday at $81. Could oil prices move up again in 2022? Sure.

Will they go up almost 70% like they have so far this year?

Probably not. Then there are the massive supply-chain issues,

particularly with computer chips, that have disrupted the

automobile market. Prices for new cars and trucks are up 9.8%

from a year ago; prices for used cars and trucks are up 26.4%.

Higher semiconductor production should curb price increases

next year and prices might even fall modestly in this sector.

The problem is that the most recent forecast from the

Federal Reserve (released September 22) suggests its favorite

inflation measure will only be 2.2% next year, which translates

into an increase of about 2.5% for the Consumer Price Index

(CPI). Sorry…put us down supporting the “Over.”

We think the Fed is making the same mistake it made last

year. At the end of last year, the Fed projected that its favorite

measure of prices would be up 1.8% in 2021, which translates

into roughly a 2.0% increase in the Consumer Price Index (CPI).

Oops! Not even close.

The M2 measure of the money supply is up almost 40%

from where it was in February 2020, substantially faster than the

pre-COVID trend. Ultimately, this is the root cause of the

inflation we’re seeing. Yes, the extra government spending

matters, too. But it matters because the Fed is monetizing the

extra debt related to that spending; otherwise, it’d just be

transferring demand from one group to another.

We think CPI inflation will run around 4.0% next year and

might continue to do so for multiple years until either the extra

M2 growth passes through the economy or the Fed somehow

drains some of the extra M2 from the monetary system.

The same thing happened in the 1970s, when the Fed

believed that rising inflation was transitory, and therefore did not

slow growth in the money supply. As long as the Fed thinks

inflation is transitory, it will not drain money from the system.

Although the Fed is “tapering,” that just means the expansion of

its balance sheet will proceed at a slower pace, not that the

balance sheet will actually shrink.

Look for housing rents to be a key source of inflation in the

years ahead. Housing rents – both for actual tenants as well as

the imputed rent of homeowners – were both artificially low last

year due to limits on evictions. Now that the limits on evictions

are over, the rental value of real estate will rise more quickly, and

rents make up more than 30% of the CPI.

The Fed has let inflation take root in the US economy. We

don’t expect to be back at the Fed’s 2.0% target anytime soon.