Inflation began reacquainting itself with its 40-year-highs toward the end of last year. Ever since, Americans have hoped that each new monthly CPI report would be the one that finally showed consumer prices were heading back to earth.
As far as that goes, however, all of those reports have proved to be a source of disappointment – including the one for August.
You may have heard the headline consumer price index (CPI) in August rose 8.3% on a year-over-year basis. Food prices remain a big problem. The “food at home” index climbed 13.5% year over year, which is the biggest 12-month increase in more than 43 years. However, there was a significant decline in the gasoline index, which fell 10.6% year over year in August.
8.3% is the lowest headline CPI since April. But you’ll notice no one is celebrating. In fact, concern about the future of inflation appears to be growing.
Why is that, if CPI seems to be in the midst of a decline?
It’s because a closer look at the details hidden inside the headline inflation number reveals that elevated prices could remain a problem for some time to come. Those details suggest a worrisome broadening of inflation throughout numerous categories of goods and services.
The implications of this broadening could be significant to the health of U.S. households. Beyond the obvious impact of ongoing inflation, Americans now must be concerned the Federal Reserve will implement inflation-fighting measures that could prove harmful to economic growth.
If there’s one thing the August CPI numbers makes clear, it’s this: High inflation now is a deeply rooted, fully embedded condition that isn’t going anywhere anytime soon. Whatever roles supply chain issues and the war in Ukraine might be playing in exacerbating monetary inflation, it does seem – as one noted economist insists – that the foundation of these higher prices is unprecedented growth in the money supply.
A little later, we’re going to talk more about monetary inflation and its implications for consumer prices through the foreseeable future. It’s an important discussion, particularly for retirement savers who are wondering if taking steps to lessen inflation’s impact is worth the effort.
Before we get to that, though, let’s see what it is that makes the August inflation report so troubling.
It isn’t the headline 8.3% inflation number that has everyone’s attention right now. It’s the core inflation number, as well as the figures for some key component indexes.
Economists like to look at core inflation – inflation minus food and energy – because they feel it gives them a better look at “real” inflation. The reason economists tend to see food and energy prices as something of a distraction is that they can be heavily influenced by factors unrelated to what’s going on in the underlying economy, such as geopolitical conflict and weather disruptions.
In their view, if inflation really is going down, then it’s the core inflation figures that will tell the story. As it turns out, however, that’s not the tale they’re weaving.
As a matter of fact, core CPI in August rose 0.6% on a month-to-month basis after rising 0.3% in July. In other words, core inflation in August didn’t merely increase at a greater rate than it did the month before; it increased at twice the rate. And that reality is sparking renewed concern about the outlook for inflation.
The core inflation number on a year-over-year basis was ugly, as well, rising 6.3% in August. That’s substantially higher than the 5.9% year-over-year increase recorded in July.
“It’s concerning that we’re not seeing deceleration,” former Atlanta Fed President Dennis Lockhart remarked about the core measure. “We’re seeing acceleration at the core level [emphasis added].”
Some component numbers stand out, in particular. Prices for new vehicles climbed 0.8% in August compared to a 0.6% increase in July. Prices for medical care services gathered significant momentum in August, rising at twice the rate they did in July – 0.8% to 0.4%. And the shelter index – which makes up roughly a third of CPI – rose 0.7% in August after climbing 0.5% in July.
More generally, there was unmistakable evidence of a broadening in price pressures across the board last month. Household furnishings and operations, motor vehicle insurance, education, apparel and veterinary care are just some of the areas that saw an increase in their inflation rates from July to August.
“The core inflation numbers were hot across the board. The breadth of the strong price increases, from new vehicles to medical care services to rent growth, everything was up strongly,” lamented Moody’s Analytics chief economist Mark Zandi. “That was the most disconcerting aspect of the report.”
Zandi added that “I have not changed my forecast for inflation to get back to [the Federal Reserve’s 2% target] by early 2024, but I’d say I hold that forecast with less conviction.”
I’ll bet. In truth, it’s getting more difficult to find anyone who now thinks we’ll see inflation back down to 2% by early 2024. Which begs the question: Where should Americans expect to find inflation through the near and intermediate terms?
Precise inflation projections right now vary considerably from analyst to analyst. Where we are starting to see general agreement is in the idea that a quick return to the Fed’s idealized 2% target level is unlikely.
For example, the consensus of those polled for the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters (SPF) is that the personal consumption expenditures (PCE) price index – a headline measure alternative to CPI that’s preferred by the Fed – will proceed this way: Creep down to 7.5% in the fourth quarter of this year, decline to 3.2% in Q4 2023, and find its way down to 2.5% in Q4 2024. In other words, per this outlook, inflation still will not have retreated all the way back to the Fed target by the end of the next two years.
For their part, the economic forecasters at Kiplinger’s project that inflation could remain particularly high through the end of this year and next. Their forecast is for CPI inflation to sit at an even 8% by the conclusion of 2022 and to still be as high as 4% by the end of 2023.
And esteemed Johns Hopkins economics Professor Steve Hanke sees headline inflation hanging around at an even higher level for some time to come.
Part of what makes Professor Hanke’s ideas on where inflation is headed so intriguing is how accurately he forecast its trajectory last year. While Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell were busy telling us inflation not only would be brief but mild, Hanke and his frequent collaborator economist John Greenwood were proclaiming that inflation would reach between 6% and 9% by the end of last year. As it turns out, inflation did exactly that, and has remained in that range through the present day.
Johns Hopkins Economist Hanke: Inflation Will Be at 5% Heading Into 2024
Throughout the current inflation cycle, Hanke has insisted there’s nothing surprising about either the levels that inflation has reached or the persistence with which it has lasted. He lays the responsibility for inflation squarely at the feet of the significant growth in the money supply over the past few years. Hanke frequently references the fact that the nation’s M2 money supply grew a jaw-dropping 41% from early 2020 through the middle of this year.
Relying on the same quantity theory of money economic model which informed both he and colleague Greenwood that inflation would reach its present heights, Hanke sees inflation as high as 8% by the end of this year and at 5% by the end of 2023.
Briefly, the quantity theory of money says the prices of goods and services change in direct proportion to the money supply. Hanke notes that another feature of the theory is that the lag between changes in the money supply and consequential changes in the inflation rate can be as long as two years, which is why he sees inflation remaining significantly above the Fed’s target through at least the end of 2023.
During an appearance on CNBC at the end of August, Hanke laid out the compelling monetarist case for why we can expect to see the inflation levels he’s projecting through the end of next year.
“There had never been sustained inflation in world history – that is inflation above 4% for about two years – that had not been the result of unprecedented growth of money supply, which we had starting with COVID in February of 2020,” Hanke said. “That is why we’re having inflation now, and that’s why, by the way, we will continue to have inflation through 2023 going into probably 2024.”
The projections of Hanke and others that higher inflation will last for years brings me once again to a point where it seems appropriate to consider the actual impact chronically higher prices could have on retirement savings
We’re going to take a look at that now.
Understandably, people tend to think of inflation’s impact first and foremost in terms of how it makes life especially difficult for them as consumers. However, no one should overlook the long-term effects of inflation on the buying power of retirement savings.
April 2021 was the first month of this inflation cycle that the consumer price index (CPI) popped well above the Fed’s 2% target level. Since then, headline inflation has averaged 6.9%. That means a retirement savings account with $500,000 cash stashed in it at the outset of April 2021 – and still has $500,000 stashed in it today – has seen the purchasing power of that money sink to roughly $455,000.
Now consider the subsequent impact on that money from inflation, at least through the foreseeable future. Let’s assume Johns Hopkins Professor Steve Hanke is right and inflation stays between 6% and 8% for the remainder of this year and hangs around 5% through the end of 2024. For purposes of this example, I’ll assume inflation averages 7.5% for the rest of this year and 5% next year (which actually may be a low-side projection if Hanke sees inflation at 5% by the end of next year).
Making those assumptions, inflation would average 6.3% for the period from April 2021 – again, when CPI first moved well above the 2% range this cycle – through December 2023. Inflation at that level and for that length of time would reduce the purchasing power of a $500,000 nest egg to roughly $422,000.
To be clear, though, inflation doesn’t have to be anywhere near its present levels to significantly reduce the purchasing power of retirement savings over an extended period.
For example, inflation that averages 3% over a period of 20 years would reduce the purchasing power of a half-million-dollar nest egg by nearly 50%. To look at it another way, in order for a retiree to enjoy the same purchasing power in 20 years that his or her $500,000 buys today – assuming average inflation of 3% over the next two decades – he or she would need that savings to grow to a little more than $900,000.
To be sure, the outlook for inflation remains uncertain – in the near term and well into the future. Will we see a return to inflation rates that reside between 0% and 2%? Or should retirement savers plan for a future where the responses to economic and geopolitical uncertainty more readily come in the form of expansionary fiscal and monetary policies that could generate chronic inflation?
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