A Covid-19 Vaccine Could Unleash Pent-Up Demand, Bringing Along Inflation

11/22/2020 | 10:14am

By David Harrison

Inflation could be poised for a comeback.

Some economists are starting to embrace the idea that a prospective Covid-19 vaccine could allow people to once again spend money on travel, restaurants and other services -- and drive up prices in the U.S.

That would be a change from the past 10 years, when inflation rarely hit the Federal Reserve's 2% target despite a strong economy and low unemployment. It would also test the central bank's new framework, which calls for periods of inflation above that level after stretches, like the current one, when it has run below.

The economy's progress since the sharp, pandemic-induced recession in the spring has made forecasters more confident of a strong recovery once a vaccine enables people to resume their pre-pandemic lives.

Airlines and hotels, which laid off thousands of workers and slashed prices at the start of the pandemic, could struggle to meet the surge in demand, sending prices higher. And city rents, which dropped as people hunkered down, could start creeping up again as they look at alternatives.

Likewise, the March coronavirus relief bill, which sent direct payments to households and increased unemployment aid, gave people more cash -- and much of it has yet to be spent, as suggested by a relatively high savings rate. Those payments will contribute to pushing the federal debt to 98% of gross domestic product this year, according to the Congressional Budget Office, the highest since the end of the World War II. That also should cause prices to rise since there is more money sloshing through the economy.

All this could push up the price index for personal-consumption expenditures, the Federal Reserve's closely-watched measure of inflation. Annual inflation by that measure stood at 1.4% in October, shy of the central bank's 2% target.

In the near term, some economists expect a short-lived boost of inflation for a month or two next spring. That is because prices fell sharply in March and April of this year as the first wave of the virus hit. Since inflation is calculated as a year-over-year change in prices, it makes sense that it should appear strong when compared to weaker baseline numbers.

The Fed will likely not react to such a temporary burst of inflation and it will subside over the summer, the forecasters said.

Some economists, however, expect it will pick up again later.

"We're bullish on [economic] growth for next year," said Ellen Zentner, chief U.S. economist at Morgan Stanley. "Some of that comes from pent-up demand for services."

Ms. Zentner sees inflation running at or above the Fed's 2% target for all of 2022.

Inflation remained tame in the years leading up to the pandemic despite a historically-low unemployment rate and strong economic growth. That suggested to some analysts that inflation may no longer respond to a strong economy as it once did. Structural factors, such as technological change or an aging population, could be holding down price growth, they said.

That thinking was among the reasons the Fed announced in August it would no longer raise interest rates pre-emptively to head off higher inflation, but would instead be comfortable with letting inflation rise modestly above 2% for a while to make up for stretches when it runs below that level. In practice, that means the Fed is likely to leave rates very low even if inflation moves higher in the next few years.

To Joel Prakken, chief U.S. economist at IHS Markit, a better explanation for the past few years of weak inflation were low oil prices and a strong dollar holding down import prices. Mr. Prakken expects oil prices to rise and the dollar to weaken as a global recovery takes hold, which he thinks will push inflation consistently above the 2% target by the middle of the decade.

How the Fed responds to a resurgence of inflation under their new framework will be closely watched.

"For the Fed to build credibility it's going to take some time," said Ms. Zentner. "It's going to take proof where inflation is running above their 2% goal and indeed they don't raise rates."

Paul Ashworth, chief U.S. economist at Capital Economics, who also forecasts stronger upward pressure on prices, said the Fed's new hands-off policy could itself drive inflation.

"Most of the Fed board of governors understand that they have to keep a lid on inflation," he said. "But you can see a world where they just get persuaded that actually we just need more time for the real economy to catch up and the unemployment rate to come down."

Not everybody believes that inflation is about to intensify. Spencer Hill, an economist at Goldman Sachs, wrote in a recent report that he doesn't expect the labor market to recover until 2024, holding down inflation until then.

Fed governor Lael Brainard, who has suggested in the past that broad structural factors could be underlying the past few years of weak inflation, said in October she didn't see inflation hitting the target on a sustained basis in the next few years.

Fed officials have made clear they don't intend to raise interest rates anytime soon.

Write to David Harrison at david.harrison@wsj.com

Corrections and Amplifications

This article was corrected at 11:08 a.m. ET because it misstated that Ellen Zentner's title was economist at Morgan Stanley. Ellen Zentner is chief U.S. economist at Morgan Stanley.

(END) Dow Jones Newswires

11-22-20 1014ET

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