Inflation’s ‘fun’ period was far too brief

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Consumer confidence has plummeted, with the widely-watched University of Michigan confidence index at its lowest since 2011. This is incongruous with the labor market being very hot. The last time confidence was this low, the unemployment rate was 9% and people were worried about the potential for a “double dip” recession so soon after the global financial crisis. Now the unemployment rate is a miniscule 3.6%. And although things are slowing, consumer spending – which accounts for two-thirds of the economy – is strong.

I went to the local Tanger Outlets mall in Myrtle Beach, SC to hang out on the weekend and look for some gym shorts. Most stores were busy. You wouldn’t see this if people were pessimistic about job prospects. We’ve heard from smart guys on Wall Street that the economy is slowing down and we have an increased likelihood of a recession, but when it comes to consumption, I just don’t see it. And good luck buying a home without running into competing bidders, even with soaring mortgage rates.

Thus, rather than employment, what is clouding consumers is inflation, which has become permanently high, with consumer prices rising faster than wages. The evening newscasts are filled with stories about skyrocketing gas prices and even about people whose rents are rising so much they may be left homeless.

These are valid concerns, but not ones rich people have. Higher-income households can absorb price increases on things like food, fuel and housing costs. Households earning less than the median income of $50,000 live on a strict budget, and when gas, food, or rent prices rise 20% to 30%, they are forced to make tough economic choices . It’s no wonder the Conference Board’s consumer confidence index among people with household incomes between $35,000 and $49,999 a year has fallen twice as much in the past 12 months as which tracks those with household incomes over $125,000.

So what about all the reports showing big gains in spending? Is it what consumers do and not what they say? Not exactly. The first part of any inflationary episode is always good for the economy. Economic activity tends to recover and wage growth is accelerating. Between early 1971 and mid-1973, GDP grew at an average annualized rate of 6%. The trick is not to be fooled by nominal GDP growth. Inflation becomes a problem if it leads to a dreadful wage-price spiral like what happened in the 1970s after the initial inflationary growth spurt.

The only thing that surprises me about the current situation is the brevity of the “fun” inflationary phase, which lasted only about six months before consumers started complaining. But perhaps I shouldn’t be surprised given how quickly various measures of what’s called the misery index, which adds the inflation rate to the unemployment rate, have gone from well below from the long-term average to well above. And it’s all down to how quickly the rate of inflation has increased.

What we’re relearning is that while inflation leads to consumer misery, it doesn’t really slow the economy down, at least not initially. The early stages of an inflationary period tend to stimulate economic activity, with people accelerating their purchases to buy now and often in bulk before prices rise further. The lesson, then, is that just because the economy is growing faster doesn’t mean it’s stronger.

In many ways, this is an indictment of Keynesian economics, most of which is aimed at accelerating the economy by increasing the money supply and credit to raise wages. But none of this is a guarantee of happiness if it leads to much higher rates of inflation. In fact, it may be the opposite. Take a look at Japan. The country has mostly faced deflation or disinflation for 30 years and its society is generally peaceful and productive.

Most low-income households would say that the faster economy we have now is no better than what we had before and would be willing to trade higher unemployment for lower inflation. Is the Federal Reserve listening?

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Jared Dillian is the editor and publisher of Daily Dirtnap. Investment strategist at Mauldin Economics, he is the author of “All the Evil of This World”. He may have an interest in the areas he writes about.

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