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“Transitory Inflation” Is the New Buzz Phrase at the Fed – Robert Aro (05/03/2021)

With April’s Federal Open Market Committee (FOMC) and Wednesday’s press conference to follow, we can anticipate some of the key words we will hear from the Fed. The first, gaining in popularity, is “transitory inflation,” or the idea some price increases are only temporary in nature…

Last month the word came up after the March FOMC meeting. On Friday CNBC wrote about the impermanence of inflation, anticipating:

the Fed is expected to defend its policy of letting inflation run hot, while assuring markets it sees the pick-up in prices as only temporary.

If inflation calculations show increases in the foreseeable future (or if more people become aware of their loss in purchasing power and increases to cost of living), talk of the temporariness of inflation may continue. The only way temporary “across the board” price increases make sense is if they are followed by a period of “transitory deflation,” reversing prices. If prices spike up, then quickly spike down, price increases were, in fact, temporary in nature; however, given the Fed’s aversion to deflation and proclivity for the printing press, it’s safe to say price decreases are not to what they are referring.

Without price reductions, the word “permanent” would better suffice. Instead, what the Fed could mean is that we’ll learn to live with (permanent) price increases, possibly aided by the highly nebulous: “wages will adjust” idea.

Consider the scenario of widespread price increases for just one year. For each subsequent year, even if prices don’t increase much, there still exists a compounding effect of the initial price inflation, which would be anything but temporary. To illustrate, if the price of lumber increases by 300% in year one, then only increases at a rate of 1% a year the following five years, lumber is still 300% higher than it was at the start of the first year, even if we call the inflation transient.

CNBC continues:

Powell is also expected to once more explain that the Fed will let inflation rise above its 2% target for a period of time before it raises rates so that the economy can have more time to heal.

Long has existed an idea about how the Fed controls inflation. In this instance, their power lets inflation rise above its 2% target so the economy can somehow strengthen. However, it leads to another word to watch for: this idea of “tightening” monetary policy.

As the Wall Street Journal said on Sunday:

The process of ending the Fed’s giant bond-buying program, and subsequently raising interest rates, will take years unless inflation unexpectedly surges.

Undoubtedly, talk of the Fed’s unwinding balance sheet should continue to be a discussion point as it nears ever closer to $8 trillion, persistent all-time highs. Putting together the idea of inflation and tightening, we are taken to a world difficult to imagine.

It is only after prices increase at a pace which has not been seen in decades, the Fed will look to raise interest rates and reduce buying of government debt. Unless the Fed’s reduction in government debt buying is taken up by private investors, we can expect further increases to interest rates. As for the $28 trillion government debt, all-time high in the stock market, and the heating up of the real-estate market, perhaps, like inflation, those too will be transient in nature… unless wages really do adjust?

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