Inflation at new levels! But it ain't the deficit and it ain't recession

I was at O'hare AIrport getting ready to fly south to my Dad's Friday morning, when I checked the headlines. And then I saw the top econ story, and said "Well ain't this is a punch in the...."

The Dow (INDU) plunged after a key inflation report missed estimates and showed a higher-than-anticipated increase in the price of consumer goods, closing down 880 points for the day, or 2.5%. The S&P 500 shed 2.7% and the Nasdaq dropped about 3%.

The May consumer price index rose 8.6% year-over-year, its highest level since 1981. Economists had forecast an 8.3% increase. The core index, which excludes food and energy prices, rose by 6%, slightly higher than estimates of 5.9%.

Those numbers sent investors reeling. Already worried about a possible economic downturn, they now fear that the Federal Reserve will recognize inflation as entrenched in the economy and increase interest rates further.

You figured that the CPI was going to be higher after seeing gas shoot up in May, but the more worrying part came from the full release from the Bureau of Labor Statistics, which indicated that there were sizable increases in prices in many ares.

The increase was broad-based, with the indexes for shelter, gasoline, and food being the largest contributors. After declining in April, the energy index rose 3.9 percent over the month with the gasoline index rising 4.1 percent and the other major component indexes also increasing. The food index rose 1.2 percent in May as the food at home index increased 1.4 percent.

The index for all items less food and energy rose 0.6 percent in May, the same increase as in April. While almost all major components increased over the month, the largest contributors were the indexes for shelter, airline fares, used cars and trucks, and new vehicles. The indexes for medical care, household furnishings and operations, recreation, and apparel also increased in May.

The all items index increased 8.6 percent for the 12 months ending May, the largest 12-month increase since the period ending December 1981. The all items less food and energy index rose 6.0 percent over the last 12 months. The energy index rose 34.6 percent over the last year, the largest 12-month increase since the period ending September 2005. The food index increased 10.1 percent for the 12-months ending May, the first increase of 10 percent or more since the period ending March 1981.

This freaked out Wall Streeters, who now figure that "higher and ongoing inflation = recession." Either from a cutback in spending due to prices rising above wages, through jobs being cut because profit growth declines, or because the Federal Reserve raises interest rates so high and so fast that asset markets crash.

UW's Menzie Chinn has a good graph that shows the trends in inflation. All the numbers are rising, both on a 1-month (annualized to a 12-month rate) and year-over-year basis. Even though the 1-month increases in core CPI aren't as sudden as what we saw this time last year (as the economy started taking off with COVID vaccinations and Biden stimulus), it is rising much more consistently and persistently in 2022.

But I'll point out that another report came out on Friday that gave more evidence that our current inflation has very little to do with America's fiscal situation. In fact, the Congressional Budget Office says the US budget deficit is plummeting in 2022.

The federal budget deficit was $423 billion in the first eight months of fiscal year 2022 (that is, from October 2021 through May 2022), the Congressional Budget Office estimates. That amount is about one-fifth of the $2.1 trillion shortfall recorded during the same period in 2021. Revenues were $768 billion (or 29 percent) higher and outlays were $873 billion (or 19 percent) lower than during the same period a year ago.

The deficit at this point last year was much larger because of spending in response to the coronavirus pandemic—mostly for the recovery rebates (also known as economic impact payments), unemployment compensation, pandemic relief through the Small Business Administration (SBA), and the Coronavirus Relief Fund—and because revenues were lower.

In fact, the deficit is lower through May than in any fiscal year that has had the GOP's Tax Scam of 2017 in effect for all 12 months. That's despite a higher nominal GDP in 2022.

In fact, the lower budget deficit and the dollar remaining near 20+ year highs should be keeping inflation down. Which means if any Republican tells you that "Democrat spending" is causing our inflation, you know that they are either:

1. Economically illiterate; or
2. Lying to you.

As for the fears that we are already in recession - we wouldn't be seeing prices for airline fares and new vehicles go crazy like this if there wasn't demand existing that would pay for it. In fact, that seems to be a supply issue where fewer vehicles were able to be on lots and flights able to be staffed to meet the big demand that we still have for these items in America. Restaurants and bars continue to see more business, and most reports indicate consumer spending is still outpacing inflation. In an economy that is 70% consumer, it becomes hard to have much of a downturn if that is still keeping up.

In addition, jobless claims and unemployment have not budged off of their near-record lows. Even last week's jobless claim increase to 229,000 is due to a seasonl quirk due to a shorter Memorial Day weekend - the actual number of claims didn't change at all vs the prior two weeks.

Since inflation is something everyone can see and feel on a daily basis, people think our economy is declining. In reality, the economy is still moving along, and jobs are still plentiful. But that fact is little solace to a lot of people these days.

Right. Most people don't know the specific definition of "recession." They likely use the term as a general pejorative to describe an economy where something doesn't feel great -- especially when the other party is in charge https://t.co/zXXv1Ikwo7

— Catherine Rampell (@crampell) June 6, 2022

So the "rising consumer prices/continued attempts to profiteer" parts of our economic merry-go-round continued in May. In the next week, we'll see if the "consumers keep spending" and "rising costs for business/rising wages for workers" parts of the spin continue.

And as I've said before, the part that stops happening first is what tells us whether we actually do end up in recession, or merely come in for a soft landing with continued growth.