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We consistently have been predicting lower price inflation for almost three years now, but we also have been predicting that the downward inflation trend would be followed by another major inflation wave. It’s likely that the next major inflation wave will begin this year and continue for at least two years. It’s also likely that it will be driven more by government actions than by the creation of new money (monetary inflation). We’ll now explain why.

Despite the famous Milton Friedman comment to the contrary, price inflation (a rise in the cost of living for the average person) is not always a monetary phenomenon. It also can be a government phenomenon. The reason, in a nutshell, is that government interventionism and deficit-spending can distort the economy in a way that reduces productivity, leading to lower production and therefore to higher prices even in the absence of monetary inflation. In very simple terms, government actions can result in the same amount of money chasing less goods and services, causing prices to be higher on average.

Going deeper and focussing on the US, by its deeds and words it is reasonable to conclude that the US government will be 1) increasing its already-massive deficits over the years ahead, 2) driving up the costs of manufacturing in the US through tariffs on imported materials, and 3) using tariffs as a negotiating tool, thus ensuring that many business leaders remain uncertain about the costs that they will face in the future. There also is a risk that the US government will take actions that discourage foreign investment in the US.

An effect of the above-mentioned government actions will be reduced investment in productive enterprises. We note, for instance, that unless the additional debt issued by the government to finance its increased deficit spending is monetised by the Fed, it will crowd out investment in private businesses (the productive part of the economy). Furthermore, as well as driving up manufacturing costs, tariffs imposed on commodity imports probably will lead to shortages of some important commodities. While this could prompt efforts to increase local supply, due to the time, energy and materials it takes to bring new mines into production this additional building activity would, for at least a few years, have the effect of applying additional upward pressure to commodity prices and popular measures of inflation.

With the government putting upward pressure on many prices by making the economy less efficient, the Fed will not be able to justify the sort of monetary interventions it conducted during 1998-2021. The following chart shows that during this earlier period the year-over-year growth rate of the Core PCE (the Fed’s favourite inflation gauge) never went above 2.7% and spent most of its time in the 1%-2% range, effectively giving the Fed cover to ‘print’ as much new money as it deemed necessary to support the stock market and stimulate economic activity. That cover will not exist over the years ahead.

In addition, with it being obvious to almost everyone that the Fed contributed in a big way to the inflation problem of 2021-2023, from now on the Fed will tread far more carefully with regard to inflationary measures.

Consequently, we expect that for at least the next couple of years the Fed will be unwilling to mitigate the crowding-out effect of the government’s expanding indebtedness.

On a related matter, periodically in the past there would be a ‘deflation scare’ — a set of circumstances during which the Fed and other central banks effectively had carte blanche to ramp up the supply of money. Due to government-created shortages and price distortions, it’s unlikely that there will be a deflation scare within the next few years.

Summing up, the world has changed. For more than two decades every economic downturn or financial crisis was met with a new round of aggressive money creation, each of which set in motion a boom that ended in the bursting of an investment bubble, a deflation scare and another round of aggressive money creation. That won’t happen in the future, because government actions will maintain sufficient upward pressure on the prices of commodities, goods and services to limit the central bank’s ability to inflate the money supply.

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