June 25, 2021

There are many different measures of inflation, but the one that the Federal Reserve considers to be most important is the personal consumption expenditures deflator, in particular the PCE deflator excluding the volatile food and energy components.

The PCE deflator climbed by 0.4% in May after having jumped 0.6% in both March and April after having climbed 0.3% in February.  The year-over-year increase now stands at 3.9%.

Excluding the volatile food and energy components the PCE deflator rose 0.5% in May, after having jumped 0.7% in April, 0.4% in March and 0.2% in February.  The year-over-year increase is now 3.4%.  This is the inflation measure that the Fed would like to see rise by 2.0%.  Clearly these recent larger-than-expected gains reflect jumps in airfares, hotel room rates, and restaurant prices as the economy re-opens and those prices rebound from recession-led declines.   The Fed is convinced that those price gains will be temporary.  We are not so sure.

The  purchases of Treasury securities by the Fed lasts year has caused money supply growth to surge.  We all learned back in our basic economic classes that money growth is the cause of inflation.  However, the length of time between a pickup in money growth and an increase in inflation is both long and variable.  Thus, the recent increase in  money growth should cause the inflation rate to climb above the Fed’s 2.0% target not just for a couple of months but for a protracted period of time.

For what it is worth, we expect the core PCE deflator to increase from 1.4% in 2020 to 4.2% in 2021, and 3.3% in 2022.  The Fed welcomes a somewhat higher inflation for a period of time to make up for the fact that the PCE deflator rose about 0.5% less than the Fed’s 2.0% target for a decade.  Keep an eye on inflation expectations.  If they continue to climb to the 3.0% mark or above, the Fed may begin to change its tune about the timing of the next Fed tightening move.  Right now they believe that the funds rate will remain at 0% through the end of 2023.  We’ll see.

We expect  a second quarter GDP growth rate of 10.0% growth.  We also look for 8.0% GDP growth for 2021 as a whole as the vaccines bring the virus under control by midyear which makes us all more comfortable to go out to eat and travel, and as the elevated level of the savings rate causes a rapid pace of consumer spending.

Stephen Slifer


Charleston, SC