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The Fed Says Inflation is Transitory. What Does That Mean? Thumbnail

The Fed Says Inflation is Transitory. What Does That Mean?

Inflation is a big topic in the financial world – and the world at large – right now. It seems like I can’t go one day without seeing a story about the rising cost of gas, beef, used cars, and the list goes on.

The US Federal Reserve has been consistent in saying they believe these inflationary pressures are transitory. But, what does that mean? And exactly how long can transitory last?

I think different interpretations of “transitory,” which means “not permanent,” have led to confusion – and frankly, derision. The Fed is thinking of the factors and rate of inflation increase as transitory while it seems like the public, in general, is thinking only in terms of inflation and the prices they’re paying for common goods.

To me, when the Fed says inflation is transitory, they mean the current high rate of inflation is unlikely to continue – not that we’re going to deflate our way back to “normal”.

I think they view inflation as transitory because nearly every single piece of inflationary pressure can be traced to one event: the COVID-19 pandemic.

Take oil and gas, for example. When the world shut down in 2020, people stopped traveling, no matter the method of transportation. That led to a glut of petroleum products – refined or otherwise – that occupied storage space. That led to oil prices dropping like a rock, including the April, 2020 oil futures contract closing at -$37.63. That led to expensive oil producers – like those in the Dakotas – capping wells as the economics of extracting oil no longer made sense. When the economy reopened, the producers – financial wounds fresh in their minds – didn’t immediately return, leading to increasing demand, low supply, and therefore increasing prices. Eventually, that production will come back, increasing the supply of oil, and likely decreasing prices going forward.

The same type of explanatory exercise can be done for all areas of the economy seeing big increases in prices at this time. It will take a while for prices to normalize, but eventually, that equilibrium will be found.

I do not think the Fed believes we’re going to see deflation as supply/demand relationships normalize, but rather I think they believe we’ll see inflation consistent with historical norms, but off the higher base created by the pandemic.

“Transitory” could, in theory, last for several years, but I think that’s unlikely to be the case. Economic data is already showing signs of normalization, supply chain challenges are slowly but surely being solved, and oil rigs are coming back online at a rapid pace, according to Baker Hughes.

I reserve the right to change my opinion should the facts change, but right now I think the Fed has it right. While increased government spending could spur higher inflation down the road, I don’t think that particular inflation driver will rear its ugly head in the data for several years, giving consumers a kind of inflation breather after the COVID-induced increases and before pressure mounts again.

Photo by Will O on Unsplash