Dive Brief:

• The prospect of inflation exceeding the Federal Reserve’s 2% target in coming months, and Congress approving a Biden administration proposal to raise the corporate income tax poses “big headwinds” to an otherwise strong economic expansion, Jason Schenker, president of Prestige Economics, told an online conference for CFOs sponsored by the American Institute of Certified Public Accountants Wednesday.  

• “Inflation and taxes are really the two big risks we’re looking at against the backdrop of improving growth,” Schenker said.

• Monthly year-over-year measures of the consumer price index during the next few months may exceed the Fed’s target and hit 3.5% to 4% because of the “base effect” from unusually low price increases during the same period in 2020, Schenker said, warning of “eye-popping inflation numbers.”

Dive Insight:

Since the start of the pandemic-induced downturn early last year, the Fed has downplayed the threat of inflation while seeking to revive economic growth with record stimulus. It has pushed down the benchmark interest to 0.25% and purchased $120 billion in bonds every month.

Fed Chairman Jerome Powell recently said after a meeting of policymakers that the central bank will press on with record stimulus and reiterated his expectation that an increase in inflation would prove transitory.

“If, contrary to expectations, inflation were to move persistently and materially above 2% in a manner that threatened to move longer-term inflation expectations materially above 2%, we would use our tools to bring inflation and expectations down to mandated consistent levels,” Powell told a press conference on April 28.

Monthly reports of inflation far exceeding the 2% target may trigger financial market volatility, including a sell-off in the bond market, an increase in yields and a strengthened dollar, Schenker said. Instability may create pressures on the central bank to reduce stimulus.

“Even though the Fed has said, ‘No, no, we’re keeping rates low for years,’ are they going to lose their nerve?” Schenker said. “Will the markets cease to believe them?”

Some economists, including former Treasury Secretary Lawrence Summers, have warned the U.S. risks a burst in inflation because of Fed accommodation and a record surge in federal spending to fight the coronavirus.

A Biden administration proposal to raise taxes, including an increase in the corporate tax rate to 28% from 21%, also poses a risk to growth, Schenker said.

“We’re probably going to see a number of taxes go up — income, payroll, capital gains, corporate tax rates,” he said. Among lawmakers “there’s going to be some horse trading in there, but this stuff is going up.”

At the same time, tailwinds are pushing the economy forward, Schenker said, noting low interest rates, fiscal stimulus, solid U.S. and global manufacturing, strengthening supply chains and e-commerce growth.