Consumer anger over inflation may emulate the 1970s

The latest US CPI report was a blow as inflation reached its highest level in three decades. But the University of Michigan consumer confidence survey released Friday is equally concerning for what it says about the impact of inflation on the economy.

It is not clear how central banks should respond, as supply chain issues are constraints “artificial”Imposed by the pandemic. Capacity utilization remains depressed, suggesting that once the pandemic wears off, disinflation or full deflation will re-emerge. But consumer confidence is at its lowest level in 10 years due to inflation. And that matters.

Looking at a long-term chart of US capacity utilization, it is clear that there has been a long-term trend toward increasing oversupply.

Low capacity utilization arguably helped solidify disinflation over the past 40 years. Even now, excess capacity should put downward pressure on price levels.

But supply chains have come under pressure as consumers have changed their consumption habits during the pandemic and manufacturing centers have faced quarantines and shutdowns due to coronavirus outbreaks.

Increasing interest rates to combat inflation consists mainly of curbing demand by reducing the growth of the money supply, making loans more expensive. That works with a considerable lag.

The bottlenecks could have ended before the effects of the changes to monetary policy take place. Clearly, central bankers feel that acting now could backfire once supply constraints are lifted, so they haven’t taken action as inflation soars.

Consumers are reaching a breaking point. Today’s University of Michigan Consumer Confidence Index release was below expectations in large part due to inflation. Earlier, Brian Chappatta of Bloomberg noted that the figures show that “1 in 4 consumers mentioned a reduction in their standard of living in November due to inflation and lower income, while older consumers reported the greatest impact”.

As renting, filling the fuel tank, and shopping for groceries become more expensive, consumers lose the ability to make discretionary purchases. If central banks are concerned about expectations fueling an inflationary spiral, they must act before the destruction of demand occurs.

This situation may not be like it was in the 1970s, when capacity utilization almost reached 90%. But since supply chain bottlenecks are likely to persist, it’s close enough that loss of purchasing power and anger over inflation become a growing threat to the economy.

(This was a post on Bloomberg’s Markets Live blog. Comments are those of the blogger and are not intended to be investment advice.)