Entrenched Inflation vs. Transitory Inflation

  • Transitory inflation tends to be short-lived and circumstantial, while entrenched inflation tends to stick around even after the immediate problems that spurred it on have resolved.
  • Examples of transitory inflation include the inflationary periods during and immediately following both World Wars, while an example of entrenched inflation is the entire decade of the 1970s.
  • It’s extremely difficult to assess whether inflation is transitory or entrenched in real time. It’s often a retrospective designation, and with all the uncertainty still swirling around, it is still wise to invest for long-term goals even though you may not see large immediate returns.

You’ve likely heard a lot of new vocabulary surrounding inflation over the past year and a half. Unless you’re a card-carrying economist, a lot of the scenarios we’re experiencing and the words we use to describe them are things Americans haven’t had to think too much about for decades.

Even during the 2008 recession, inflation didn’t play as big of a role in determining economic policies as it does today. So it’s understandable if you’ve heard terms like “transitory inflation” or “entrenched inflation” and don’t fully understand what they mean for you and your investments.

Today we’ll delve into the distinctions between these two terms and examples of how each type of inflation has played out in the past.

The difference between Transitory Inflation and Entrenched Inflation

Transitory inflation is a short-term problem. For example, in the summer of 2021, President Biden’s administration assessed the current inflation as transitory because they thought it would stop when our global supply chains were resolved.

But in 2022, the Fed has been warning that the inflation we’re seeing might not be transitory – it might become entrenched. And, in fact, there is a lot of chatter on Wall Street about a new era of high inflation, and what this new normal might look like.

If inflation were entrenched, it would mean that prices would not come back down, and that the new prices we see in the market would be a more permanent fixture in the economic life of Americans. This is particularly true as inflation has started to impact “sticky” sectors where prices rarely come down after they spike – like rent and medical services.

Examples of Transitory Inflation

During and immediately following WWI and WWII, the U.S. experienced inflation related to war-time shortages. However, when we settled back into times of peace, prices ebbed. Other examples of transitory inflation include U.S. participation in other wars, like the Korean War and Operations Desert Shield and Desert Storm.

These are examples of transitory inflation – inflation that is due to temporary problems and is rectified once the underlying problems are resolved.

Examples of Entrenched Inflation

The 1970s was a period of entrenched inflation, where prices were high for more than a decade. This was spurred on largely by Nixon’s decision to decouple the dollar from the gold standard and two large spikes in oil prices.

During this time, the Fed went back and forth from issuing high rates and then dropping them to try to control and stabilize the economy without causing an all-out recession. But this strategy didn’t work as prices swung so often the economy never could fully stabilize.

What ultimately worked to stabilize prices was when the Carter-appointed chair of the Federal Reserve Paul Volcker held interest rates high for a long period of time – long enough to spur on a recession. This happened at the end of the 1970s and the beginning of the 1980s. The decision made Volcker an extremely unpopular man, but it ultimately stopped the inflationary problems experienced over the previous decade.

No one wants to be responsible for a recession, but when inflation becomes entrenched, the monetary policies that cause recessions can also sometimes be the solution to stabilizing prices.

How do you tell the difference between Transitory Inflation and Entrenched Inflation?

Much as it’s difficult to determine exactly when a recession starts and ends until long after it has concluded, it’s extremely difficult to determine when inflation can no longer be classified as transitory and has become entrenched – unless you’re looking at the situation retrospectively.

For example, the inflation after both World Wars could have easily become entrenched had world events played out differently. We had to wait until a time of peace came when inflation ebbed before we could definitively say the inflation in the U.S. had been transitory.

In the early 1970s, there may have been hopes that inflation was transitory, but as time wore on it became clear that after a decade the inflation had become entrenched.

While the Fed is warning that inflation could be entrenched in the near future – or may even be entrenched now – they’re still hopeful enough to try and avert that circumstance.

We do not know what lies around the corner. World events – whether they be pandemics or wars – could resolve or become worse, heightening or relaxing the supply chain issues and geopolitical conflicts that led to this round of inflation in the first place.

What Entrenched Inflation could mean for the economy long-term

If the Fed continues to raise interest rates, we could be looking at a recession. In the past, recessions have caused companies to cut labor costs, which results in Americans losing their jobs.

Whether or not past patterns will repeat themselves is not guaranteed. During this period of inflation, we don’t necessarily see labor costs being the root cause. Instead, things like sustained supply chain issues, geopolitical conflict and larger corporate profit margins appear to be the main drivers of inflation.

That doesn’t mean companies won’t respond with layoffs. Even though labor costs may not be the main contributing factor to inflation, wages have generally gone up in 2022. While it’s likely a big enough increase to cause the wage-spiral that some economists are raising alarm bells over, it is an excuse companies can use to raise profit margins and/or cut their workforce.

Regardless of the cause, recessions are a time when the average household tends to lack an adequate amount of income to meet the price requirements of running their home – whether that’s because prices are too high, income is too scarce, or both.

What Entrenched Inflation could mean for your investments

Entrenched inflation and associated recessions are not going to yield high times for the stock market. If companies are cutting costs, they’re just not as focused on growth. That means stock prices are not as likely to rise.

It also means your return on investments may not keep pace with inflation in the short-term. However, over the long haul, the stock market tends to outperform inflation even after accounting for the down times that come with recessions.

To manage your investments over a long time horizon without succumbing to the fears that arise during periods of transient inflation, entrenched inflation, or a recession, it can be helpful to continue investing at the same rate you were before and allow AI to handle the stress of picking securities and allocating your assets.

Q.ai’s Inflation Kit and Portfolio Protection can help you protect your gains and limit your losses without the extra stress. Our artificial intelligence scours the markets for the best investments for all manner of risk tolerances and economic situations.

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