Have We Entered “The Great Inflation 2.0”?

“The Great Inflation” is a momentous period in U.S. economic history that lasted for 17 years between 1965 and 1982. During this time, the world’s largest economy experienced high levels of inflation that even went into double digits. History books tend to attribute this to the U.S. Federal Reserve (Fed) being too complacent about potential increases in inflation and too fixated on tackling unemployment. The painful memories of the 1930s and the Second World War had a role to play in this.

Undoubtedly, we live in a different world today, but certain parallels can still be drawn. The Fed’s current stance is that inflation is likely to be transitory. The central bank is therefore in no real rush to pull back its unprecedented monetary accommodation that it introduced during the COVID-19 crisis. Markets, it appears, do not share that view, given that inflation expectations are continuing to rise (see figure 1 below).

Figure 1: U.S. Inflation Expectations Have Continued to Rise in Recent Months

Figure 1_US Inflation Expectations Have Continued to Rise in Recent Months

For definitions of terms in the chart, please visit our glossary.

Why might markets be challenging the narrative the Fed is currently subscribing to? There are four potential reasons. 

First, the confidence markets have in the Fed’s ability to control inflation without creating tectonic shifts in asset markets may be diminishing. This is evident from the short and sharp spikes in the CBOE Volatility Index (VIX) around the Federal Open Market Committee (FOMC) meetings this year. While supporting financial markets may not be part of the Fed’s mandate, the central bank has become increasingly conscious of market movements in recent times. 

Second, realized levels of inflation have started rising more broadly. Most recently, the eurozone’s annual inflation rate has accelerated to 2% in May, up from 1.6% in April, and above consensus forecasts of 1.9%.1 While such readings are influenced by so-called base effects—i.e., the increase in the prices of inputs like oil—inflation could be sustained at a higher rate if commodity prices continue to rise and a commodity super-cycle is indeed underway. 

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