The Role Airlines Play Driving Inflation And Today’s Down Market

Markets began tanking this morning on a higher than expected 8.2% increase in the Consumer Price Index. Food and energy costs are drivers of this, but so is airfare. Here’s why fares are going up, and why the airlines – through their conscious decisions – have caused a piece of inflation that’s driving down markets.

Yikes: Airfare component of September CPI #inflation up by 42.9% y/y, fastest rate on record

— Liz Ann Sonders (@LizAnnSonders) October 13, 2022

Like energy costs, airfare is recovering from depressed levels. But it’s not only that. Passenger demand has outpaced seat growth, in part because airlines retired planes and pushed out workers during the pandemic. Numerous airlines have scaled back their schedules to ensure they could operate as planned, lacking the wherewithal to deliver on planned flights. Airfares represent less than 1% of the basket of goods considered in CPI, but are helping to drive the number higher.

Without the ability to deliver seats, planes have been especially full even at high cost. In that sense, airlines’ failure to honor the full employment purpose of pandemic subsidies ($54 billion in direct taxpayer cash, on top of subsidized loans, tax breaks, and cash for partners that wound up bolstering their balance sheets) means higher prices today, higher measured inflation, and lower markets.

Higher inflation is driving down markets because it’s taken as a signal that the Federal Reserve will raise rates more aggressively than expected, or rather than the Fed is less likely to reduce its rate of increase. That’s probably correct.

All of the burden of reducing inflation is falling to the Fed, when in fact there are really (3) major policy levers that could be put into play (and indeed were a part of slowing inflation in the early 1980s).

  • Monetary
  • Fiscal
  • Regulatory

At root, inflation is a function of too much money chasing too few goods. The fed ‘controls the money supply’ (albeit indirectly) but a significant portion of inflation has been driven by fiscal growth (increased government spending). That’s not being scaled back, in fact immediately following the Inflation Reduction Act – whose only mechanism for reducing inflation was supposed to be increased taxes, reducing net government outflows – the Biden administration announced an even more costly program of student loan forgiveness.

But money supply isn’t the only issue, it’s just one side of the equation (really, the quantity of money along with how quickly that money is being spent). The other side is available goods. We can grow our way out of inflaton, and policies that mean more goods and services in the economy are anti-inflationary. Rather than a deregulatory stance, the current administration has pursued its opposite. And so we’re left with the Fed tinkering with the money supply.

The challenge here is, as Harvard’s Greg Mankiw reminds us, monetary policy acts with a lag. The hope for a ‘soft landing’ is nearly impossible, since the Fed will nearly always overshoot (and if it doesn’t it will be pure accident).

There’s a delay of “six or nine or twelve or fifteen months” between its policy moves and where the market ends up, “[h]ence they feel impelled to step on the brake, or the accelerator, as the case may be too hard.”

I don’t know whether the Federal Reserve is currently too hawkish, but they do not know either. I do know that the airfare component is one piece of today’s inflation numbers, and that’s driven both by the desire to travel (and money in consumers’ juiced-up pockets to do so) and also by airline capacity which was constrained even as carriers took taxpayer money to prevent those constraints.

(HT: @crucker)

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