Price spike triggers new political debate on inflation

New data showing a higher than expected May jump in inflation underscored how a bumpy recovery from the coronavirus recession poses political challenges for President Biden and the Federal Reserve.

The consumer price index (CPI) rose 5 percent in the year leading into May, the Labor Department reported Thursday, marking the fastest annual increase since August 2008 and slightly exceeding the expectations of economists. The CPI minus food and energy prices, which are more volatile, also rose 3.8 percent

The CPI, a closely watched gauge of inflation, was driven higher primarily by factors analysts expect to be temporary, such as a national used car shortage, a rush of diners back into restaurants, and demand for certain goods outpacing manufacturers’ ability to supply them. 

For those reasons, most economists and investors saw little cause for alarm in the new data. The S&P 500 index set a new record shortly after the release of the report, and the bond market showed little concern about a potential emergency rate hike in the future.

“Demand has been much stronger than many anticipate and that demand has caused supply bottlenecks, which has put pressure on prices,” said Joseph LaVorgna, chief economist of the Americas at investment firm Natixis who advised former President Trump’s National Economic Council (NEC) in 2020.

“However, once the U.S. economy fully reopens and overseas economies more fully reopen, you’re going to see these price pressures mitigate.”

Biden and Fed Chair Jerome Powell may be able to take solace in hopes of a smoother future, but the short-term bumps still pose considerable political challenges for both the White House and central bank.

Republican lawmakers insisted Thursday that the new inflation data showed the peril of Biden’s plans for trillions in further spending and Powell’s commitment to keeping interest rates near zero percent through 2021 and beyond.

“The combination of the Fed’s average inflation targeting and its view that inflation will be transitory virtually guarantees the Fed will be behind the curve if inflation is enduring. Congress' massive spending contributes to the problem. It's time to end it,” said Sen. Pat Toomey (R-Pa.), ranking member on the Senate Banking Committee, in a Thursday tweet.

Biden and the Fed also took more heat from former Treasury Secretary Larry Summers,  the chief Democratic critic of his agenda, who insisted that the May report underscored the danger of further stimulus for the fragile economy.

“The confidence with which inflation serene economists hold to their views, even after being repeatedly surprised, is a mystery to me,” tweeted Summers, who also served as NEC director for former President Obama.

“Reasonable people can disagree,” he continued. “But I do not see how any responsible policy maker can fail to recognize that overheating is now the largest risk in the near term.”

With months until inflation rates could move back toward historic averages, Biden and Powell are likely to battle concerns about rising prices throughout the summer. 

That dynamic poses obstacles for both Biden and Powell at pivotal moments for each.

Biden has spent months in so-far fruitless negotiations with Republicans over a potential deal on infrastructure as Democratic lawmakers get increasingly impatient. But the president is also struggling to unite Democrats around a much larger package to pass through budget reconciliation with almost half of the year gone.

At the same time, a 2019 deal to waive the legal limit on the federal debt expires in less than two months. Republicans have already signaled they will refuse to support a debt ceiling hike without spending cuts, which could trigger a high-stakes budget battle as Biden attempts to cement trillions in infrastructure spending.

“Today’s 5 percent increase in the inflation rate is the highest since 2008 and makes one thing clear: President Joe Biden’s partisan trillion-dollar spending sprees are raising prices on groceries and gas and everything in between,” said Sen. Bill Hagerty (R-Tenn.) in a statement.

For Powell, the pressure comes amid his push to keep the Fed unified around its new framework, and financial markets patient with a turbulent economy. His performance could influence not only the Fed’s credibility, but also whether Biden renominates him later this year with Powell’s term set to expire in February.

Many economists said that while the near-term should be challenging for Biden and Powell, the May inflation numbers showed a range of temporary headaches that cause few long-term risks.

Prices for used cars and trucks soared more than 7 percent between April and May, making up one-third of the total increase in the CPI. There has been intense demand for used cars in 2021 as rental companies rush to replace fleets they liquidated in 2020, but have struggled to find available autos. 

Other items posting large price increases were recovering from crisis levels one year ago, including airfares, vehicle insurance, restaurant meals, and rents. 

“We are entering what will no doubt be a long, hot summer as consumers continue to spend faster than most producers and service providers can keep up,” wrote Diane Swonk, chief economist at Grant Thornton, in a Thursday analysis. “The report reminds us of the transitory nature of price hikes and how consumers react.”

LaVorgna said that the current state of price increase gave him little reason for concern, but warned that the dynamic could change drastically if Biden can push through the obstacles between him and another massive spending bill.

“If we do that, the Larry Summers school of thought, I think, is very, very legitimate. You will take a transitory inflation problem and potentially make it a permanent inflation problem,” LaVorgna said.