MNI INTERVIEW: Covid Drag Fades, Prices Tame-SF Fed Economist

The drag on U.S. consumer prices from the Covid demand slump has nearly receded, Federal Reserve Bank of San Francisco economist Adam Shapiro told MNI, adding that he sees scant evidence of supply bottleneck effects and little risk of inflation rising above 2% over the medium term.

"My forecast is inflation is going to start picking up as the unemployment rate starts to fall, but it's going to happen very gradually, and it's going to be a long persistent road ahead to get back up to 2% again," he said in an interview, pointing to scant evidence of supply bottlenecks pushing prices higher. "I don't really see any strong risk to inflation going above 2% or so far above 2% that there's any worry about inflation being too high."

His latest research on the impact of the pandemic on inflation underscores Fed Chair Jerome Powell's message last week that the Fed is likely to look through transient bouts of higher inflation this year, despite rising market bets on a future inflationary shock.

Shapiro, who has broken down the categories of core PCE inflation that have been affected by the pandemic into demand-sensitive, supply-sensitive and ambiguous groups, finds that the drag on inflation from falling demand for certain goods and services is close to disappearing.

DEMAND SHOCK EBBS

Whereas demand-sensitive categories contributed -0.7 pp to core PCE inflation in April, the effect shrank to just -0.1 pp in December, the latest month for which data are available. Core PCE inflation was 1.5% in December, up from 0.9% in April.

"It looks like we're heading back to where we were before the pandemic hit," Shapiro said. "At the onset of the pandemic, there was a big demand shock, so prices fell. Since March, it's been dissipating, and now is pulling down inflation by just 10 to 20 bps."

Upward price pressure from Covid-related supply constraints has shown little change through the pandemic, contributing just 0.2 pp to core PCE inflation in December, the same as it did in April. Categories in the supply-sensitive group include flowers and seeds, major household appliances and musical instruments.

"You could have a one-time increase in price, but that's not what inflation is," he said. "For that to happen, they not only have to increase once but twice and over and over again. You'd need unanchored expectations, and there's no evidence of that happening."

The rising inflation narrative in markets "reminds me a lot of what happened in the Great Recession," when many expected QE to fuel a sharp rise in inflation, which "just didn't happen," Shapiro said. "What the Fed is doing is preventing deflation. Unemployment is still high there's still a lot of slack in the economy, so it would be hard to generate inflation even with all that stimulus going on."