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Inflation Is Headed Lower—but Maybe Not Low Enough

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The bad news is that in April, for the second month in a row, inflation clocked in above 8%. The good news is that sometime in the next 12 months, it will very likely fall to around half that. This isn’t exactly a heroic forecast. Bottom-up analysis of the consumer-price index’s components, inflation-linked bond yields, and wage behavior all point toward inflation settling at roughly 4%.

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The more important question is what comes after that? The hope by many—including the Federal Reserve—is that it keeps heading down toward the Fed’s 2% target by itself. But there are good reasons it will stay around 4% or even drift higher. That wouldn’t be acceptable to the Fed, and opens the door to even higher interest rates than markets now expect, more market carnage and a weaker economy.

1652359816 350 Inflation Is Headed Lower—but Maybe Not Low Enough

The number of container ships waiting off the coast of California has decreased significantly.


Michael Ho Wai Lee/SOPA Images/Zuma Press

The forces that drive inflation tend to move slowly, so the almost unprecedented surge since early 2021 means something anomalous is going on. In fact, only twice since the late 1940s has inflation risen as much as in the past year, and both were periods like the present, when supply shocks hit a hot economy.


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In 1951, the economy was already booming when the Truman administration warned that mobilization for the Korean War would “pull men and materials, as well as plants, away from existing peacetime uses,” fanning inflation. JPMorgan economist

Michael Feroli

has constructed an index of economic disruption based on how much employment growth varies between individual sectors. It shows disruption was exceptionally high during the Korean War and the Covid pandemic. The Korean War analogy is comforting because while the Fed did tighten monetary policy, it avoided a recession. Inflation shot from 2% in mid-1950 to 9.6% the following April, and was back below 1% by December 1952.

In 1973, the Arab oil embargo hit an economy already trying to cope with soaring food prices and strong demand. As an analogy for the present, this episode is a lot less comforting than 1951: Inflation peaked at 12.3% in 1974, and the Fed raised interest rates sharply, triggering a deep recession. Even so, inflation only fell back to 5% in 1976—then headed higher.

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