inflation forecasting chart

Making Sense of the Great Inflation Debate of 2021

Fear of inflation reaching record highs is dominating the financial news and driving some investment behavior — but is long-term worry justified?

Rising prices can be viewed as a byproduct of a robust, booming economy and an indicator that the U.S. is recovering from the effects of the pandemic. They may also be feared as a harbinger of financial doom.

Many aspects of the present economic climate seem poised to set inflationary records: unprecedented government spending, low interest rates, an excess of cash available after a slowdown in financial activity lasting almost a year, and a global supply chain still experiencing pandemic-related difficulties. With an upshot in demand meeting a pronounced lack of supply, it’s no wonder rising inflation has been a big news story.

The Consumer Price Index (CPI), a widely used measure of inflation that surveys the price urban consumers pay for common goods, experienced its largest monthly gain since 2008 in June 2021 and is still well above average for the year. The June 2021 Survey of Consumer Expectations conducted by the New York Federal Reserve Bank showed that fear of rising prices among purchasers is on a steady incline, for both the near-term and three-year outlook.

Members of the Federal Reserve Board met in June amid rumors of pending interest rate increases. That didn’t happen. And as of now, the Fed has reiterated its commitment to providing “powerful support” to the U.S. economy by keeping rates low through the recovery. 

As revealed in the Federal Reserve Board’s June meeting minutes, Fed officials are divided over how serious a threat rising inflation poses to the nation’s economic outlook. Described as “antsy” by one account, some of the central bankers worry about the economy “overheating.” Others, including Fed Chair Jerome H. Powell, “maintained a more serene tone.” 

Each month’s rising numbers have widened this divide and increased the unease among markets and consumers. 

Developments in financial markets

As the U.S. economy reopens, buoyed by the rising percentage of vaccinated adults, some economists remain cautious about declaring full recovery. Variants of the coronavirus pose a threat to unvaccinated Americans, of which there are still many. While average hourly earnings for all employees is up, employment growth is lower than some projections, with the labor market experiencing uneven recovery across demographic groups and industry sectors. The energy sector, as well as the commercial building industry, remain weak. 

Some recovery effects are creating difficulties for consumers, who may be experiencing less buying power than they had pre-pandemic. The housing market is booming — home prices are up 15% or more across the U.S. — and demand is far exceeding supply in many areas. Even buyers flush with cash and aided by low interest rates are priced out of some previously attainable neighborhoods. 

According to forecasters at Fannie Mae, housing costs could drive up inflation by as much as two percentage points by the end of next year. Some market watchers believe the state of the housing market could impede economic growth by “spooking” the Fed into raising interest rates.

Are worries overblown or understated?

Even the most experienced economic experts, some of whom sit on the board of the Federal Reserve, believe the status of the U.S. inflation rate is complicated and uncertain. A new study gives academic weight to this point: No groups have been able to forecast inflation rates with any consistent accuracy — not economists in academia, and not the bond market. 

But even those who disagree about how high inflation may go in the next year agree that there are safeguards in place to stop it from spiraling to the 13.5% peak it hit in 1980. To put things in perspective, inflation in the U.S. has not exceeded 5.4% since 1983. 

Prognosticators generally do not have an impressive track record in predicting inflation rates, nor how their acceleration could impact an economic recovery. Moreover, the unique circumstances of the COVID-19 pandemic make it difficult to apply even the most accurate forecasting techniques of the past. And just the hype surrounding expectations of increased inflation from official sources “can become a self-fulfilling” prophecy.

Potential impact on the investment community

Many market watchers have told investors to prepare for continuing volatility throughout the second half of 2021. Many concur that multiple factors can be blamed for the recent increase in the inflation rate — and it could continue indefinitely if no measures are taken to curb it and its underlying causes. 

Longer-term, “safer” investments are viewed as a safeguard against volatile markets, but now investors must also factor in how those investments will fare against steadily increasing inflation rates. Many of the “tried and tested” strategies can fall short during periods of high inflation. Some experts look to the “broad basket of commodities” approach, assuming that as prices rise, the value of their underlying goods will, as well.  

Some news outlets have reported that the Fed’s ambivalence is worrying investors. With that in mind, Fed Chief Powell is among those experts presenting a more optimistic front, even in the face of unsettling monthly reports. While acknowledging that rates are climbing well above the Fed’s “comfortable” 2% measure, many still forecast that the rates will return to “healthier” levels as the recovery continues. 


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