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What Is Transitory Inflation?

what is transitory inflation

Transitory inflation is a term that gained wide circulation in 2021 as the initial impact of the COVID pandemic subsided and prices for many goods and services began rising steeply after several years of very low levels of inflation. Federal Reserve Chairman Jerome Powell used it early in the year to describe what he saw as a temporary phenomenon that didn’t require anti-inflationary action. Consider working with a financial advisor to help interpret and respond to inflation’s effects on your finances.

Basics of Inflation

Generally, inflation refers to a broad increase in prices for goods and services over a period of time. Inflation is usually measured by the Consumer Price Index (CPI). It is calculated by the Bureau of Labor Statistics and measures the average change over time in prices for many consumer goods and services. Inflation is different than the cost of living.

Inflation is closely watched by investors, economics, business leaders and policymakers because of its potentially negative effects on the economy. By making it more expensive for businesses to acquire materials and supplies and hire employees, inflation can slow economic growth and worsen unemployment. It also decreases the future purchasing power of cash and can lead to broad declines in the stock market.

The Federal Reserve Bank is charged with maintaining low unemployment and low inflation. It tries to accomplish this by managing the money supply through securities purchases and controlling borrowing costs by setting interest rates for loans to banks. The Fed aims to have an inflation average of 2% percent a year. When inflation deviates from that target, the bank uses its tools to urge it higher or lower.

History of Transitory Inflation

what is transitory inflation

Economists have described transitory inflation as the opposite of chronic inflation at least since the middle of the last century without much disagreement or controversy. Transitory inflation was understood to be a temporary phenomenon that would not lead to a permanent increase in the rate of inflation.

In April 2021, however, inflation shot up 4.2% compared to a year earlier, roughly tripling the typical rate of inflation for the prior several years. At the time, Federal Reserve Chairman Jerome Powell suggested the increase was transitory, caused by the pandemic economic re-opening process and didn’t require Fed action.

However, as the year progressed upward pressure on prices accelerated. By November, inflation was running at 6.8% annually. By then, Powell’s description of inflation as transitory was being widely criticized as inaccurate, given the sharp and persistent rise in prices. At the time, Powell explained that the Fed had meant it to describe inflation that, in addition to being temporary, was unlikely to have a permanent effect on the economy. Then he suggested retiring the venerable term entirely.

By the time the annual inflation rate hit 8.6% in May 2022, the Fed had already begun increasing its target for the fed funds rate governing overnight loans to banks in an attempt to corral inflation. Given that the May rate was the highest in 40 years, it was clear that inflation represented a real threat to the economy. The next month, at its June meeting, the Fed’s Federal Open Market Committee (FOMC) raised the fed funds rate by 0.75%, the biggest move since 1994.

The transformation of the runup in prices that began in 2021 from one described as transitory to one requiring urgent and powerful action illustrates the difficulty of forecasting inflation’s course, as well as the importance placed on doing the job well. As Powell put it in an August 2021 speech, “Central banks have always faced the problem of distinguishing transitory inflation spikes from more troublesome developments, and it is sometimes difficult to do so with confidence in real-time.”

Bottom Line

what is transitory inflation

Economists have long described short-lived spikes in inflation as transitory, but the term’s meaning became muddled as it was used to apply to suddenly resurgent inflation in the wake of the initial impact of the Covid pandemic. After being criticized for not acting aggressively enough to deter inflation increasingly seen by many as anything but temporary, Federal Reserve Chairman Jerome Powell indicated he’d stop employing the term completely.

Tips for Dealing With Inflation

  • Federal Reserve policymakers aren’t the only ones who struggle to evaluate and respond effectively to inflation. As an ordinary investor, you can harness a financial advisor’s expertise to help you make the right moves. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • SmartAsset’s inflation calculator is a free, fast, easy and accurate way to estimate the personal financial effects of inflation. It helps users see how the buying power of a dollar changes over time using historical rates of change in the Consumer Price Index for urban consumers.

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