The economic shock of the COVID-19 pandemic was exceptionally disruptive by many measures, particularly in the sharp decline in consumer spending in the first half of last year. Temporary supply disruptions resulted in short-term price increases for some goods and services, but the broad impact of collapsing demand was disinflationary. That risk has since faded, replaced by growing concerns of undesirable inflation pressures taking root, fueled by massive fiscal and monetary stimulus and the Fed’s stated intention of allowing inflation to exceed the central bank’s 2% target for some period. Although the CPI is set to rise in the coming months, a range of factors suggest that intermediate-term inflation pressures should remain relatively muted. History provides a glimpse of what to expect.
Inflation typically trends lower after the cyclical peak in the economic cycle, and tends to remain well-below prior cyclical peaks well after a recovery begins. Economic downturns generally have a lasting impact on consumer and business behavior, creating a more cautious approach to consumption and investment. It takes time for excess economic slack to be absorbed, helping to keep upward price pressures largely in check.
Global economic slack, elevated unemployment, and demographic constraints on labor force growth in the U.S. are all disinflationary, and the economy is far from overheating. The potential for higher inflation ahead certainly exists but shouldn’t be overstated.
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