The Political Impact of Inflation Is about to Snowball

A fter April’s (relatively) restrained inflation numbers, many Democrats began to breathe a sigh of relief, thinking that inflation might be on a downward course. This was a mistaken assumption but also one that ignored the uncomfortable reality that future price increases will generally be measured off a higher base, something that is often overlooked.

Today’s inflation report provided new support for the view that the wage–price spiral that leads us down a path to sustained and accelerating inflation has begun. The Biden administration touted the reduction in inflation in April as a sign that its inflation-fighting policies were working. Even ignoring the fact that the administration had no such policies, it was obvious to all that the April numbers were a blip attributable to a brief decline in gas prices, a decline that more than fully reversed itself in May. Now we have the numbers to prove it, and the happy talk from the White House is yet more proof that Biden and his team have no clue what is going on with the U.S. economy.

The carnage in the report was severe, especially with respect to the typical consumption basket of middle America. Relative to a year ago, to smooth through the monthly blips, food prices were a whopping 10 percent higher in April. Energy prices have now increased 34.6 percent over the past year. Gasoline prices are up 48.7 percent, and fuel-oil prices are up a whopping 106.7 percent.

When year-over-year increases are this high, some argue that one should ignore food and energy prices because they are so volatile. Implicit in this assumption is the idea that what goes up must come down, an idea that grew out of the Federal Reserve in the 1990s. At the time, Fed scholars conceded that what mattered for consumer welfare was top-line inflation, but they found that future top-line inflation (the thing that should guide a Fed that is steering an oil-tanker economy; it takes a long time to change course) is better forecasted by inflation excluding food and energy prices (that is, core inflation) than by inflation itself. Back then, gasoline prices would spike because of unrest in the Middle East, and then go back down quickly. Such a cycle is sadly unlikely now. And without it, the story can get much worse.

The fact is that food prices are higher because all of the key inputs to food production are skyrocketing in cost: Wages are higher, workers are scarce, fertilizer prices have seen a historic increase, and diesel fuel is through the roof. Food prices are going to continue to head north, especially as wages try to catch up to inflation.

If we look at core inflation, its more moderate gain likely just means that it has some catching up to do. People who make cars, for example, have seen the price of new cars increase by 12.6 percent over the past year, while used-car prices are up 16.1 percent. At the same time, their food and energy costs have skyrocketed. If they negotiate wages that are just enough to cover inflation, car prices will have to go up even more.

Okay, a Biden supporter might say, fine, but people will get used to these higher numbers and inflation will become less of an issue over time. Yet the opposite is true, and the reason is that factor that Einstein (allegedly) called the eighth wonder of the world: compounding.

Stable inflation is not here yet, but when it does arrive, we will likely be looking at inflation in the 7 percent range as far as the eye can see. The thing that non-economists might easily miss is that inflation’s negative consequences on consumer welfare build steadily over time. Two years of 10 percent inflation, something that seems like almost a sure thing going forward, has the same effect on prices as ten years of 2 percent inflation. But the difference is that in year three, whatever inflation comes then and thereafter will be growing from a general price level that will be 21 percent higher than it was two years ago. Even lower inflation will move prices relative to the start of the cycle more than would have happened if inflation has stayed stable at 2 percent.

To put it a different way, somebody on a fixed income of $20,000 a year has seen the value of their income decline by about $2,000 over the past year, and will likely see another similar decline next year. Even if inflation stabilizes after that, they’ll still be trying to get by on 20 percent less money for the rest of their life, and they are sure to get angrier and angrier about it.