Is the inflation really transitory?

Webster suggests transitory means “temporary,” “not persistent.” Perhaps transitory inflation can thus be best understood as only a brief period of time whereby the prices of goods and services increase.

The term "transitory" is becoming more common in discussions about inflation in India and around the world. Inflation has been higher than projected and has been increasing at a faster rate than in previous decades. The major central banks, on the other hand, have labeled it as transitory because it is mostly driven by one-off causes. They anticipate significant price hikes as a result of one-time variables that are not sustainable. However, the present list of one-time factors is extensive and diverse. As a result, the term "transitory" inflation does not imply a short-term price increase.

What happened in history?

When Fed Chairman Ben Bernanke testified to Congress in July 2011, increasing inflation was on everyone's mind. During the first half of the year, oil prices had soared above $110 per barrel, and the cost of filling a car tank with gasoline had doubled from just two years ago. The dramatic rise in food costs acted as a spark for a series of revolutions across the Middle East, now known as the Arab Spring. The consumer price index (“CPI”) increased by as much as 3.9% YoY, far exceeding the Federal Reserve's long-term inflation objective of 2% per year. Investors and consumers were concerned about inflation because of rising prices and the Federal Reserve's continuous purchases of US Treasuries and mortgage-backed securities, which many saw as inflationary.

Chairman Bernanke's prediction that inflation would be temporary in 2011 was spot on. Between 2012 and 2016, the year-over-year growth in consumer prices was between 0% and 2%.

Current scenario – US

Consumer Price Index:

Prices that Americans pay for everyday goods and services rose in July as pent-up demand for travel and restaurants kept inflation hot, but jumped about as much as economists had expected. The government said CPI increased 0.5% on a month-over-month basis. Economists and Fed panelists have stated that the current inflation trend is within their tolerance band and the current inflation is in line with their expectations.

Producer Price Index:

The producer price index increased by 7.8%. Nearly three-quarters of the increase was due to the 1.1% rise in prices for final demand services, the largest on record. Almost half of the increase was due to a 1.7% rise in margins for final demand trade services, which measure changes in margins received by wholesalers and retailers.

With the release of this latest inflation data, Federal Reserve Chairman Jay Powell finally admitted that the present inflationary impulse is higher than the Fed had anticipated while maintaining the current rate of inflation.

The Fed chairman, Jerome Powell, has been steadfast in his view that the spike in inflation is transitory; that it is a function of the disruption to supply chains caused by the pandemic and the distortions generated by the unprecedented fiscal response.

The annual Jackson Hole meeting which is to be held from the 26th to the 28th of August - is when the markets are expecting the Fed Chair Powell to provide more insights on when and how will the Fed start tapering its bond and mortgage purchases and its more current assessment of when the first rate rise in this cycle may occur. Inflation readings and the unemployment numbers would be the major catalysts.

 Current scenario – India

Retail Inflation based on Consumer Price Index eased to a three-month low of 5.59% in July due to moderation in food prices. The inflation print has come within the RBI’s targeted range of 2 plus/minus 4% after two months, easing concerns of an immediate rate hike action by the central bank.

The RBI governor stated that “High rates of inflation are transitory and Inflation is showing signs of stickiness, but it is only a transitory hump that should moderate in the third quarter,".

RBI Governor also underlined the need to closely monitor the price hike situation in order to anchor the inflation expectations. RBI also revised its inflation forecast for FY22 to 5.7% from 5.1%. The RBI Governor still held onto the fact that the increase in inflation is just temporary.

RBI communications show that inflationary concerns don’t figure on their priority list for now. Like major central banks, RBI has consistently communicated that they are willing to look through any transitory inflation till ‘durable recovery’ returns. The MPC members seem to believe that it’s their duty to support growth recovery from the pandemic by providing ample liquidity.

Conclusion

The real transitory part is the very temporary inflation from a set of quirks related to the economy’s reopening impacting core prices. Supply chains are complex, and they have come under pressure during the pandemic, as companies are faced with challenges including raw material shortages, rising input prices, and longer delivery times.

This unusual dynamic could also last much beyond the next few months and will only reduce when the manufacturing costs come down.

Central banks apparently believe that they will only need to worry about entrenched inflation when demand returns. But it may well pose the biggest threat to the current nascent economic recovery. It’s premature to conclude all of this is transitory and where underlying inflation is ultimately going to land when we get through the price normalizations. The government is also running massive fiscal deficits and many central banks worldwide are beginning to consider how to pause or pare their accommodative stances.

Over the long run, there are several themes that would drive inflation dynamics. Below we list a few of them: 

1) In the long run, if the de-dollarization continues, Commodities denominated in dollars would be impacted.

2) A purposefully weak Yuan and low-cost manufacturing has helped China export deflation around the world. So, it would be important to understand whether China would be comfortable with a stronger Yuan, given its inward emphasis and talks surrounding Yuan internalization.

3) It is believed that delays in mining clearances and limiting the supply of metals that are needed for the green push would have an effect on inflation. Also, factors surrounding climate change may have an impact on prices.

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