All of this increases the stakes for the Fed. Despite the numerous positive headlines about rising consumer purchases and lower unemployment claims, the disruptions have increased costs for businesses in industries from furniture to groceries. This could spike inflation if passed on to consumers, undermining Biden’s hopes for a robust recovery and pressure on the central bank to raise rates far earlier than desired.
“The economy is a fine mesh, in which everything fits together and which has been torn apart by the pandemic,” said Jason Furman, a professor at Harvard University and former chief economist to President Barack Obama. “We just hope it all comes back together.”
Supply chain problems emerged during the pandemic when people radically shifted what they bought – canned drinks instead of fountain drinks, sweatpants instead of suits – to overthrow the normally efficient order of global supply chains.
At least temporarily higher prices would bring supply and demand back into balance, a dynamic that the Fed – as the country’s inflation policeman – has been watching closely. The central bank has argued that price increases due to supply disruptions will only have a short-term impact on inflation data, and Chairman Jerome Powell says the Fed will not act to raise interest rates unless there is a longer-term matter of shifting the price level up.
“There is a difference between a one-off rise in prices and persistent inflation,” Powell said last week. “Inflation is usually determined by the underlying inflationary dynamics in the economy, as opposed to congestion.”
However, the Fed’s anecdotal analysis of different regions of the country known as the “Beige Book” this week showed that supply chain disruptions were occurring in almost every industry, limiting an otherwise bullish outlook for the economy.
“This supply disruption is reaching the breaking point where we need to start raising prices and we will see inflation,” said Jim Bianco, director of financial analyst Bianco Research.
In the meantime, a key question is how markets will react when inflation rises, even if it’s temporary. So far, the Fed has attributed gradual increases in US Treasury bond yields to the brightening outlook for the economy, a scenario that should bode well for both stocks and bonds, as faster growth also drives long-term corporate performance is positive.
However, should yields rise sharply on fear of inflation among bond investors, it could result in the Fed withdrawing support for the economy earlier than expected, bursting financial bubbles and affecting the recent record-breaking stock market rally.
“If rates go up because real growth is creating a huge demand for credit – great,” said Bianco. “But when rates go up because of inflation, that’s a problem for the stock market.”
The most well-known supply problem is the global shortage of computer chips caused by the increasing demand for technical products as millions of people have moved to work from home. This has impacted industries like automobile manufacturing as cars are now so dependent on computerization.
Biden convened a group of CEOs Monday to discuss the issue and said there was bipartisan support to increase funding for U.S. semiconductor manufacturing. His own infrastructure plan would set aside $ 50 billion for this purpose. However, it would take years for the results of these efforts to manifest, and they would do little to help tackle the crisis in the short term.
Other bottlenecks could be resolved more quickly, with mismatches being more likely to be due to the difficulty of planning ahead in a situation that remains very uncertain.
“It’s easier to turn off the lights in a plant than to turn it on,” said Diane Swonk, chief economist at Grant Thornton. “The recovery of goods came as a surprise in many cases.”
The reopening of many restaurants, for example, has seen a surge in purchases of packets of ketchup with one serving, but there is only so much capacity to produce them at once. And unless it is clear that the higher demand will continue, companies may not want to invest in expanding their manufacturing capacity.
“If I were in the aluminum can business, I would be reluctant to order new machines until I knew what the well business was like,” said Scott Miller, senior advisor at the Center for Strategic and International Studies. “I would do a lot of market research in Florida and Texas, where bars and restaurants are reopening, to see how much of the shift is temporary and how much is permanent.”