Inflation Again

It used to be that inflation was just part of life: the 11% increase in consumer prices in 1974 and the 9% rise the following year seemed inevitable at the time, and even after Paul Volcker painfully put the kibosh on inflation in the early 1980s, annual price rises hung around 4% for a decade. These kids today (he says disdainfully) don’t know anything about that. Over the past decade, the average annual inflation rate in the United States has run well below 2%. Many people who didn’t live through the inflation-ridden ’70s or ’80s have come to take that as normal. A recent study by the Cleveland Fed estimates that the financial markets are pricing in a U.S. inflation rate averaging 1.37% per year through 2030.

I hope they’re right, but I’m not so sure. In my new book, Outside the Box, I argue that international trade, and in particular trade in manufactured goods, will decline in importance in the coming years, growing more slowly than the world economy. This is likely to have important effects on the inflation rate in the United States and around the world.

Since the early years of this century, the vast influx of goods from East Asia has played a major role in holding down U.S. consumer prices. The abrupt shift of manufacturing supply chains to East Asia, while extremely painful for U.S. factory workers, caused a flood of cheap imports. Bedroom furniture costs about 8% less than it did twenty years ago, according to the Bureau of Labor Statistics, while prices of clocks and lamps have fallen by two-thirds. Such drastic price drops have allowed the Federal Reserve to control inflation without raising interest rates so high that they choked off economic growth.

But that’s history. As manufactured imports account for a smaller share of Americans’ spending, they will become steadily less important in restraining prices. The Fed will have to rely more heavily on its power to influence interest rates to do the job of keeping inflation down. And that doesn’t allow for the likelihood that the federal government will rely on inflation reduce the burden of repaying the trillions of dollars of debt it has issues to keep the economy alive during the COVID-19 pandemic. That’s why I expect 2.5% mortgages and 10-year Treasury bills yielding a fraction of one percent interest won’t be with us for long — and why there’s a good chance that inflation rate over the coming decade will be a percent or two higher than the benign rates we’ve become used to.

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