the federal reserve

Inflation Surged in June. The Fed Should Do Nothing About It.

Used-car salesmen are in the driver’s seat.
Photo: Gabriela Bhaskar/Bloomberg via Getty Images

Consumer prices in the U.S. surged last month, exceeding economists’ projections and pushing inflation to its highest point in more than a decade.
The consumer price index rose 0.9 percent between May and June, the highest monthly gain since 2008. This brought annual inflation — the growth in prices over the past 12 months — to 5.4 percent. That jump can’t be attributed to volatile food and energy prices: Core CPI, which excludes those items, grew by 4.5 percent over the past year, the largest such advance since the first Bush presidency. Wages failed to keep pace with this historic price spike; in June, real average hourly earnings fell by 1.7 percent.

None of this should change Federal Reserve policy.

America’s central bank has a mandate to promote full employment and price stability. These objectives can come into tension. When the Fed deems job growth its top priority, it keeps benchmark interest rates low, encouraging an expansion in private lending and thus higher consumer demand. If demand grows faster than the economy’s productive capacity, however, consumers will start bidding up the prices of scarce goods. Then, faced with a “hot” economy’s rising prices and abundant job opportunities, workers will have both the will and the capacity to demand wage increases. And that could lead employers to jack up prices further, leading workers to demand still higher wages, leading employers to jack up prices further in a vicious inflationary cycle. In order to preempt such a development, the Fed has often raised interest rates at the first sign that inflation might be headed north of its 2 percent target.

Now, with the Fed’s benchmark interest rate near zero — and the 12-month CPI above 5 percent — inflation hawks are clamoring for the central bank to pour cold water on the post-COVID recovery. Their case is superficially plausible but substantively bankrupt.

If the quantity of June’s CPI growth surprised economists, its composition did not. As expected, price growth was (once again) heavily concentrated in sectors that are either rebounding from the pandemic or suffering from COVID-induced supply shocks or both. That’s critical for the Fed: The central bank’s leadership has said it will not raise interest rates in response to transitory price spikes. If the Fed remains faithful to this sound policy, the new CPI data will not change its course.

Last month, used cars were the top drivers of inflation in the United States. More than one-third of June’s CPI increase was attributable to previously owned vehicles, which are now 10.5 percent more expensive than they were in May — and an astounding 45.2 percent pricier than this time last year.

Graphic: Ben Casselman
Graphic: Bloomberg

Loose monetary policy didn’t cause runaway inflation in the secondhand auto market; COVID did. The forces fueling the car market’s dysfunction are twofold:

• Faced with a global recession in 2020, many manufacturers of semiconductors — a critical input for many new vehicles — slowed down production. But demand for microchips only grew as the COVID crisis deepened: Unable to safely purchase vacations or nights out, the middle classes of developed countries increased their spending on electronic goods. This mismatch helped yield a global shortage of semiconductors, which has hobbled new car manufacturing. In recent weeks, Chrysler and Ford have been forced to halt production of their marquee pickup trucks for want of microchips.

• In 2020, car-rental companies responded to the collapse in tourism by selling off their fleets. Now, as the economy recovers, Enterprise, Alamo, and others are scrambling to replenish their inventories by buying up used cars.

As a result, there aren’t enough new cars to satisfy ordinary levels of consumer demand, let alone heightened demand amid the post-pandemic drift out of urban centers. Meanwhile, in the used-car market, consumers must compete against car-rental companies for America’s limited supply of spare vehicles. Inflation in the used-car market may also be boosting demand for rental cars: In June, the average price of a rental car or truck was 87.7 percent higher than it was one year ago.

This represents a major public-policy challenge. If skyrocketing car prices make overall inflation look worse than it actually is for Americans who aren’t in need of a new vehicle, overall inflation also understates the cost burdens facing those who do need a cheap replacement for their jalopies. The microchip shortage will be temporary. As lumber’s recent meteoric rise and fall illustrate, the supply of basic inputs will generally rise to meet demand. Still, experts now believe the semiconductor shortage could persist into next year.

But jacking up interest rates — until credit becomes so expensive that employers stop hiring, consumers stop borrowing, and car prices go down because fewer Americans can afford them — would not be a sane policy response to this problem.

Another major contributor to June’s inflation was the tourism industry’s recovery. Hotel prices rose 7 percent last month, yet room rates fell so low in 2020 that last month’s massive gain merely brought hotel prices back to their pre-pandemic norm. Similarly, a 2.7 percent increase in airfares in June — following a 7 percent increase in May — still left the cost of a flight lower than it had been before COVID arrived in the U.S.

Graphic: Ben Casselman

The same basic story holds for apparel. Clothing costs 4.9 percent more now than it did one year ago; at that time, however, clothing was 7.3 percent cheaper than it had been in the summer of 2019.

There are some hints of inflationary wage pressures in the food-service sector. The price of “food away from home” did not fall during the pandemic’s early months, and it is now about 4.2 percent more expensive than it was last summer. And the price of “limited-service meals” — also known as fast food — is 6.2 percent higher now than in June 2020. This suggests that recent wage gains for servers at limited-service restaurants may be putting durable upward pressure on prices. But this doesn’t seem like a problem. Workers at Chipotle recently secured a roughly 18 percent increase in wages. To compensate for this spike in labor costs, the firm increased the price of a burrito bowl by about 30 cents. Unless one is indifferent to the longtime stagnation of working-class wages — which the Fed officially is not — this seems like a worthwhile trade.

To be sure, the Fed’s expansionary monetary policy, combined with Congress’s historically large COVID-relief bills, has contributed to inflation by propping up consumer demand. But these demand-side policies have done more to mitigate poverty and expedite recovery than to fuel a general price increase. This point is well illustrated by the Cleveland Fed’s median CPI tracker. Median CPI aims to “provide a better signal of the underlying inflation trend” than the standard consumer-price index by omitting outliers: The measure removes all items that saw exceptionally large or small price changes. By this metric, the underlying inflation trend in the U.S. is actually negative.

What’s more, average long-run inflation is still well below the Fed’s target. As Matthew C. Klein illustrates for Barron’s, since annual inflation came in below 2 percent for years after the financial crisis, prices today are much lower than they would have been had the Fed consistently hit its 2 percent target over the past decade.

Given all these considerations, the case for the Fed to tighten credit, and thereby subordinate job growth to price reduction, is exceptionally weak. Raising interest rates won’t mint more microchips, but it would slow job growth at a time when America’s unemployment rate sits near 6 percent. The post-pandemic economy has a lot of problems. Cheap credit isn’t one.

Prices Soared in June. The Fed Should Do Nothing About It.