Olivier Blanchard, a former chief economist at the International Monetary Fund who was among the first economists to warn of rising inflation in the final days of the pandemic, said inflation may now fall on its own because the inflation shocks of the 1970s seem to be absent.
With inflation rising in the 1970s, a series of events led to a steady rise in prices. Perhaps the clearest example of this is the fact that many unions have taken concessions from management to include inflation in annual wages. While this was beneficial to workers, it also paved the way for companies to charge higher prices. These changes have been called the "second cycle effect".
Speaking at the International Monetary Fund on Friday, Blanchard said he was surprised by the lack of second-round effects.
"I was very concerned about spillovers – other changes in prices and wages – there were no spillovers in the US," Blanchard said.
The lesson, he said, is that the Fed has too much confidence in inflation over the medium term.
People seem to say. "Well, inflation is there, but it's not here to stay," Blanchard said.
As with oil prices, there will be more pressure on prices from the supply side of the economy. He advised the Fed not to respond to price movements by sharply raising interest rates.
Blanchard said he expected inflation to disappear after the massive COVID relief packages passed by Congress during the pandemic.
While Blanchard was right about inflation, he said he was wrong about the causes behind it.
Blanchard said he believes the federal government's stimulus payments will increase demand, lower unemployment and put more pressure on wages.
But it didn't happen like that.
Instead of a labor market, inflation led to price hikes, large increases in basic commodity prices, energy and food prices, and shortages of other commodities.
Blanchard noted that the reason for the sudden increase in commodity prices is not clear.
But the good news is that commodity prices have now stabilized, so the labor market remains the only driver of price growth.
"The job market is overheated right now, so the Fed needs to slow down," he said.
“Inflation itself will come down a bit, but it won't reach 2 percent.