US consumer prices are rising at the fastest rate for several years.

But the rate of inflation is still being flattered by the modest increase in energy prices, masking the impact of faster increases in food products and other commodities.

If energy prices rise further in the second half of 2021 and into 2022, as the expansion matures, inflation could prove more persistent than anticipated by officials at the Federal Reserve.

Inflation has accelerated most sharply in the goods sector, where manufacturers have struggled to meet the surge in demand.

As a result, prices for merchandise other than food and energy are increasing at the fastest rate since the early 1990s.

Officials at the Fed have said the acceleration will prove temporary, with price increases slowing in 2022 and 2023.

But inflationary pressures normally intensify as a business cycle becomes longer and more capacity constraints emerge.

It would be unusual for inflation to slow as employment rises, manufacturing capacity becomes more fully used and service sector output increases.

The relationship between inflation and the business cycle is often obscured because the cycle is presented as if it exists in two states: recession and expansion.

The two-state model is a simplification. In fact, the rate of growth is variable; recessions are the most pronounced slowdowns.

The long boom between 1991 and 2001 was almost derailed by a sharp mid-cycle slowdown in 1998/1999. The expansion between 2001 and 2007 lost momentum in its early stages and threatened to stall in 2002/2003, prompting the Fed to cut interest rates again to try to entrench the recovery.

During the expansion of 2009-2020, a similar early-recovery stall occurred between 2010 and 2012, prompting the Fed to launch further rounds of bond buying.

Later in the same expansion, there was an even more serious mid-cycle slowdown in 2015/2016. Experience suggests inflationary pressures are likely to abate if the recovery threatens to stall or enters a mid-cycle slowdown.

If the US economy avoids both in 2022/2023, inflation will accelerate further and necessitate a tightening of monetary policy earlier than the central bank has indicated. /London, June 11 2021



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