Tom Barkin

The following text is a lightly edited version of remarks delivered at the Raleigh Chamber Partners Forum on June 24, 2021.

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A little over a year ago, we shut down the U.S. economy to slow the spread of COVID-19. It was a painful, difficult process, and thankfully, we seem to be on the other side. But it turns out that reopening our economy isn’t easy either. Who would have thought that the same auto plants that went idle last March would once again be closed — this time because of a chip shortage? Who could have imagined flying somewhere but not being able to find a rental car when you land? And who would have expected hotels, restaurants and theme parks to be paring back their menus and hours just when consumers are ready to travel and eat out again?

We are seeing elevated net worth — from fiscal stimulus, quarantine-suppressed spending and rising asset prices — funding pent-up demand from consumers exhausted from isolation and freed by vaccines and warmer weather.

That demand is outpacing supply. Inventories are low. Ships have been backlogged at West Coast ports. The ice storm in Texas disrupted chemical manufacturers. Chip shortages are limiting auto production. The inventory of houses for sale is historically low. Manufacturers who got behind during the downturn have struggled to catch up.

Many firms are also constrained by an inability to find workers. The jobs opening rate is the highest it’s been in the 20-plus years of that data series. But at the same time, strangely, the unemployment rate is still elevated at 5.9 percent, and 7.1 million fewer people are employed than before the pandemic. What’s the story here? In part, we’re seeing a drop in labor force participation driven by parents with elevated care responsibilities and a surge of retirements. In addition, stimulus payments and a year of reduced spending might have given workers the financial wherewithal to be more selective about pay, working conditions or health risks. We might also be seeing regional, sector or skill mismatch between the people looking for work and the open jobs. These labor constraints are particularly notable at lower wage levels.

Basic economics teaches that strong demand plus limited supply equals higher prices. And it has. In May, 12-month headline PCE rose at a 3.9 percent annual rate. The 12-month core PCE, which strips out more volatile food and energy prices, rose at a 3.4 percent annual rate. And fast-growing prices are making up a larger share of overall spending — in May, prices went up more than 10 percent for nearly 18 percent of the items in an inflation measure produced by the Dallas Fed.

So the topic on many people’s minds is inflation. And why wouldn’t it be? We’ve got high reported data, spiking commodity prices, trillions in fiscal spending, significant Fed asset purchases, rates at zero, unexpected supply chain outages at a time of severe pent-up demand, a depreciating dollar, short labor supply and a daily media drumbeat about higher prices.

But how concerned should we be? I’ll note that the word “inflation” conjures up different things for different people. Businesses, conscious of their tight margins, focus on input prices, which have soared; central banks pay attention to changes in the overall price level, which have been moderate until just recently. Consumers feel inflation when food and gas prices rise, yet their volatility takes them out of our core metrics. Businesses focus on today and the customer resistance they face when they raise prices; central bankers focus more on tomorrow and what expectations are for prices down the road. And market measures of longer-term inflation compensation, like the TIPS indices, have stayed steady as the recent data has come in, at effectively the Fed’s 2 percent target.

During a recent discussion, one of the economists on my team posed the question, “What decade are we in?” How you answer that question informs what you think we will see in the coming years and the optimal path forward for policy.

You might think we’re in the 1970s: a period of high inflation that didn’t end until the Volcker interest rate increases of the early 1980s. For sure, inflation has increased recently, and we even saw gas lines last month. But it’s hard to ignore how much of the current rise in inflation is due to temporary factors. Used car price increases were a third of last month’s increase. Return –to normal prices in the travel industry were another big factor, as were supply chain challenges across the spectrum. You have to imagine many of these increases will ease and that we may even see price reversals — daily car rental rates won’t be $400 forever because more supply will come online. A great cure for high prices is, well, high prices.

You might think we’re in the 2000s, when — after a period of low rates — inflation increased and the equity and housing markets exploded before collapsing and causing the Great Recession. For sure, valuations are up, housing sales are frenzied and price increases are at September 2008 levels. But it’s hard to ignore how much more stable the financial system has become, with less leverage in the housing market and in the banking system. Bank risk weighted capital ratios are at a record high 14.3 percent today, compared with 9.8 percent in the third quarter of 2008.

You might think we’re in the 2010s, when many people feared the Fed’s low rates and asset purchases would lead to inflation, but that fear never really materialized. PCE inflation did increase somewhat to 2.5 percent in 2011, but it reverted once temporary pressures subsided and then remained below 2 percent for many years. That path could well repeat itself. Of course, it’s hard to ignore the long list of present-day inflationary events I described earlier; presumably they will have some impact on inflation expectations.

Or you might think we’re in the mid-1960s: when inflation started its acceleration after almost two decades of stability. Perhaps you see a risk that inflation expectations once again become unanchored, given the similarities of sizable fiscal deficits and accommodative monetary policy. But while one should never say never, it’s hard to ignore the number of other factors that led to the Great Inflation, including no longer pegging the dollar to the price of gold, the rise of OPEC and wage and price controls — as well as the lockstep compensation and price environment of the time given pattern bargaining and regulated industries. And today’s Fed has learned the lessons of that era.

The decade game is a fun one. Maybe you think automation will cause a productivity boom like the one that limited inflation in the 1990s, or that we will have a short but steep inflationary cycle like we saw as the economy adjusted at the end of World War II. Or maybe you look at all this excess savings and want to imagine a return to the Roaring ‘20s.

For me, all I can say is that every decade is unique. I do believe we are in the middle of a temporary adjustment cycle, during which workers will return to the workplace as schools open and fiscal payments expire, and suppliers will catch up to demand. For those reasons, I expect our near-term inflationary pressure to ease as we go into the fourth quarter.

The key question, then, will be whether this episode has a significant lingering effect on businesses and consumers. Will they accept higher annual price increases going forward? I think the past 30 years of relative price stability must outweigh a few months of pressure. But one can never be too careful. That’s why you see the Fed starting our process of discussing normalization, and hopefully why you hear legislators talking about how they will pay for their proposed spending packages.

History doesn’t repeat itself, but they say it can rhyme. So I’m hoping for a 1940s-era temporary price adjustment process, followed by a return to the growth and price stability we experienced during the 1950s and mid-1960s. But every decade has its story, and we will soon see what is ours.