Some economists and investors are warning about the threat of rising inflation even with the U.S. still struggling to recover from deepest recession ever. What’s behind these seemingly sudden inflationary fears and and how big is the threat? MarketWatch explains.
Why all this inflation talk?
Washington has already approved about $3 trillion in financial aid for families, unemployed workers and struggling businesses since the onset of the pandemic last spring. Now the Biden administration is seeking another $1.9 trillion.
These are astonishingly huge sums. All that extra money sloshing around along with record low interest rates, the thinking goes, has already pushed stocks to record highs. It could also trigger a massive boom in pentup consumer spending if the coronavirus vaccines are effective and the U.S. economy makes a full recovery.
Businesses in turn would respond to the surge in demand by raising prices.
Ergo, higher inflation.
What is the worry?
Inflation erodes the value of money. Families fall behind when prices rise faster than their paychecks. Higher prices also drive up interest rates and favors bonds over stocks.
The worst-case scenario envisions an unexpectedly large increase in inflation by early next year topping well over 3% that forces the Federal Reserve to raise interest rates sooner and more aggressively than expected.
The results could be devastating. Higher inflation and interest rates could send stocks /zigman2/quotes/210598065/realtime DJIA -0.36% plummeting, choke off growth in a still-healing economy and potentially even induce another recession.
The Biden stimulus could “set off inflationary pressures of a kind we have not seen in a generation,” wrote former Democratic Treasury Secretary Lawrence Summers in a widely read op-ed published in the Washington Post .
How likely are higher prices?
Very. Inflation is on the rise again and is certain to move higher in the next year.
How come? The cost of many goods and services fell early in the pandemic amid a brief collapse in demand and they are now returning to precrisis levels. And prices for some key raw materials such as lumber and soy beans have already gone through the roof.
The consumer price index, the main tool for measuring changes in the cost of living, rose in January at a 12-month pace of 1.4%. It had tumbled to a yearly rate of almost zero last May from a 2.3% clip just before the crisis started.
Even the pre-pandemic level of inflation overstates the problem, however. Inflation has generally been quite tame over the past decade and mostly fallen short of the 2% target the Fed thinks is optimal for the U.S. economy.
“We believe that underlying trends will remain locked close to 2% when the dust settles,” wrote chief economist Douglas Porter of BMO Capital Markets.