CPI Gives Reason for Cautious Optimism on Inflation

Inflation may finally be coming down. July’s month-to-month Consumer Price Index (CPI) increase dropped to zero last month, down from 1.3 percent in June. The core CPI inflation rate remained unchanged at 5.9 percent over the last 12 months. The big headline-generating number, of how much the CPI has increased in the last 12 months, went down from 9.1 percent to 8.5 percent. It’s a mixed picture, but inflation might finally have peaked.

The bad news is that even in the best-case scenario, inflation will remain higher than normal into next year.

The reason why July’s CPI may be a little too rosy is that part of its fall is due to falling energy prices, which have nothing to do with inflation. CPI can’t tell the difference between inflation and non-inflation price changes It just tracks all price changes that occur for any reason, so it overstated inflation in the months after Putin’s invasion of Ukraine, and it is understating inflation now that energy prices are falling.

Oil prices’ ups and downs are due to supply and demand, whereas inflation has to do with the amount of dollars in circulation. Putin’s Ukraine invasion disrupted oil supplies and raised prices, which are now coming down as people adapt. But because this had no effect on the number of dollars in circulation, it didn’t affect inflation.

The timing is right for inflation to be peaking right around now, because the Federal Reserve’s actions have lag times of six to 18 months. We are in that window right now for the worst of the Fed’s pandemic-related money creation spree.

To give an idea of the imbalance the Fed created, it has grown the M2 money supply by more than a third since COVID hit, while real output is up only about 4 percent. The Fed’s job is to keep the money supply in sync with real output. It abandoned that mission during COVID because it felt the need to stimulate the economy during the pandemic, and it overdid it. We are paying the price for that mistake now.

That six-to-18 month lag time is also why inflation will remain high into 2023, even in the best-case scenario. The Fed didn’t begin correcting course until March, and even then, it has taken only baby steps in hopes of avoiding a recession. There hasn’t yet been enough time for the Fed’s reversal to start working its way through the economy. Once it does, the effects will likely be small for the first several months.

Congress and President Biden have little control over inflation, but both are desperate to be seen to be doing something in an election year. They are doing more harm than good. The CHIPS Act will add $79 billion to the national debt over the next decade, making the Fed’s job harder than it needs to be. The Inflation Reduction Act will have no measurable effect on today’s inflation. It pushes out most of its fiscal discipline measures to 2027 and beyond, long after the current inflation will have passed. That post-2027 discipline will also almost certainly be canceled out by future spending increases. They should instead rein in spending, and lighten trade and regulatory barriers that are preventing economic growth.