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Opinion Sorry, Democrats. The inflation problem is far from over.

A customer places items on a conveyor belt at a checkout counter at a Harmons Grocery store in Salt Lake City in October 2021. (George Frey/Bloomberg News)
5 min

President Biden on Wednesday rightly celebrated the news that the inflation rate for July had fallen relative to previous months. But the underlying data suggest this could just be the calm before the coming economic storm.

July’s rate was so encouraging largely because of energy prices, which dropped by 4.6 percent. That included a 7.7 percent drop in gasoline prices, which have continued to decline since July. That means there might be further good news in next month’s report.

But this masks the underlying problem. The average gas price has declined by almost a dollar a gallon since its high point in mid-June, but it is now only at March’s level. At a little more than $4 a gallon, gas is still almost 30 percent pricier than it was in June 2021. The massive sudden rise in prices, not the recent decline, is likelier to weigh on people’s minds when they assess how things are going.

Even more important is that prices continued to rise in virtually every other important economic sector. Food prices are an especially problematic area for Biden. They rose by 1.1 percent last month, making them 11 percent higher than they were a year ago. Inflation was even higher for dairy products (rising 1.7 percent last month) and grain products (1.8 percent higher). In other words, food items are getting more expensive every time Americans visit the grocery store. That omnipresent fact drives home the importance of inflation to every consumer.

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Housing prices are the most ominous indicator of future, stubbornly high inflation. They increased by 0.5 percent in July, almost no change from the prior month. That puts housing prices at 5.7 percent higher than last year and shows that demand continues to outstrip supply for this essential sector. Shelter constitutes one-third of the entire consumer price index. If housing keeps rising at a nearly 6 percent annual rate, it’s unlikely the rest of the index will drop below that level for extended periods.

All this means the Federal Reserve will continue to be hawkish on inflation for the foreseeable future. Its discount rate is still only 2.5 percent, well below inflation. And with the latest unemployment report still showing a strong jobs market, there’s little sign the Fed’s recent tightening has slowed the economy much at all. So it’s likely the Fed will continue its pattern of hiking the discount rate in 0.75 percent jumps.

Biden surely hopes the Fed can engineer a so-called soft landing, a reduction in inflation without triggering a significant recession. But that’s increasingly unlikely. Americans are spending down their pandemic-era record savings, but still have trillions of dollars left in the bank. This lets them continue to spend even as they grumble about rising prices, and that keeps economic activity high.

It will take them a few more months of drawing down their bank balances before they will have to start cutting back. That could coincide with high interest rates, producing a double hit to the economy. The likely result: an end to the hot job market in early 2023 and further declines in gross domestic product.

No amount of wishing will make these facts go away. Our current inflation is a direct consequence of our response to the pandemic. We flooded the economy with money through the multiple aid packages and reduced the supply of services that constitute the bulk of our economic activity. That created the savings buildup, and when supply constraints were lifted as the pandemic eased, the money had to go somewhere. We won’t return to pre-pandemic rates of inflation and growth until the balance between the supply of money and the supply of goods and services is restored.

That will likely mean much higher interest rates than we have had for more than a decade. The historic relationship between the Fed’s discount rate and inflation was clear before the 2008 financial crash. The Fed usually kept its rate above the inflation rate before then, providing savers with a low, but positive, real rate of return. The Fed chose to break with this to battle the crash, pushing its discount rate below inflation and keeping it there until 2019. Truly battling inflation means returning to the old practice. Interest rates need to be high enough to keep a significant chunk of those pandemic-era savings in the bank.

Biden’s best course would be to level with the American people and tell them the truth: We will be fighting the pandemic’s effect on the economy for years. But his penchant for quick solutions and soothing harmony means he’s not likely to do this. Instead, he’ll promise quick and relatively painless returns to normalcy that won’t happen. The last American president who tried that approach in an economic crisis was Herbert Hoover.

Inflation is not going away until its underlying causes go away. That won’t happen quickly, no matter the happy talk coming out of the Oval Office.