Markets weren’t too surprised to see a run-up in inflation in much of the world in 2021, aware that prices in a reopening economy would be compared with the low year-earlier prices that prevailed during COVID-19 lockdowns. But readings have been hotter than forecast as supply in a range of goods and even in labor has failed to keep up with resurgent demand.
With accommodative monetary and fiscal policies expected to remain in place for some time, could inflation at rates we’ve seen in 2021 persist in 2022 and beyond?
It’s not our base case. Our proprietary inflation forecast model, described in the recently published Vanguard research paper The Inflation Machine: How It Works and Where It’s Going, tells us that the U.S. core Consumer Price Index (CPI) will likely cool from recent readings above 4% toward the U.S. Federal Reserve’s 2% average inflation target by mid-2022. Our model then foresees a further uptick toward the end of 2022, assuming fiscal stimulus of about $500 billion is enacted this year.
“Fiscal stimulus, though, is a wild card,” said Asawari Sathe, a Vanguard U.S. economist and the paper’s lead author. “If we see $1 trillion or more in additional, unfunded fiscal spending enacted this year, core inflation could pick up more sustainably toward the end of 2022 or in 2023. This risk of persistently higher inflation is not fully anticipated by either the financial markets or the Federal Reserve forecasts and could lead the Fed to start raising short-term rates sooner than its present timetable of 2023.”