Is There Virtually No Inflation? Tariffs Aside, We Have Another Supply Shock At The Doorstep: Electricity

If inflation feels virtually nonexistent to some, that may soon change.

The May CPI release showed a much slower pace of price increases than expected. Some of that reflects lagged effects to housing components of inflation relative to events that transpired 2-3 years ago. And it is also true that the much-vaunted tariff effects have yet to leave a blatant mark on the macroeconomic data. Make no mistake, you can start to see the tremors of tariff effects in the inflation data if you look under the hood, but other effects have dominated the last couple months. Given the volatility of policy in the past 10 weeks, it's not surprising that the full impact of policy has yet to leave its mark on how firms price their goods to consumers.

Yet there is an inflationary supply shock now at our doorstep even if we set aside the tariff effects: electricity. Across most of the PJM interconnection region, which represents roughly 20% of the United States, prices are now adjusting to reflect tightened capacity conditions. PJM is a regional transmission organization (RTO) tasked with coordinating electricity generation capacity across several high population states in the Midwest and Mid-Atlantic regions. Its independent market monitor has noted that data center demand has surprised expectations and caused load growth to inflect after a long period of relative stability. Back in 2024, PJM made revisions to the reliability of its generation sources. But only after settling with multiple states has it gone forward with a system for raising prices, which is only now being passed on to consumers. Across New Jersey, Ohio, Pennsylvania, and Maryland, electricity rates are poised to rise at least 10% and more commonly around 20%, in some cases as soon as June itself. By the time we reach the end of this month, ratepayers in these states are likely in for a rude awakening, especially as temperatures rise and cooling demand with it.

We are very skeptical that monetary policy should be responding directly to these types of supply-oriented impairments, and we also worry about counterproductive impacts on investment. If anything, now would be the right time for the Fed to be outlining a framework to avoid making policy mistakes around their biggest Achilles' heel: supply shocks.

But we also wouldn't use this moment to proclaim there to be virtually no inflation. There are growing gaps between capacity and demand in electricity, especially as data center appetite for power continues apace. And as that dynamic continues, American workers and families are likely to feel some real squeeze to their paychecks and incomes. Businesses are also vulnerable to seeing materially higher cost structures, with some risk of secondary passthrough to final goods and service prices.

At the same time, the critical moves that need to be made now are on the supply side. Federal and state government lawmakers should be working to grow and diversify electricity generation capacity. With natural gas prices doubling over the past year and gas turbine manufacturing in a multiyear bottleneck, lawmakers would ideally leverage fiscal and regulatory policy to support additional investment along a broader scope of viable sources and solutions. Unfortunately, we are more likely to see the tax burden increase across a range of investments in additional capacity and production. That would only serve to prolong the requisite price adjustment and pain stemming from the underlying capacity crunch.

Regardless of where you fall on these policy debates, it would be a mistake to think that inflation as experienced by consumers has fully concluded. Nor would it be correct to think that tariffs are the only threat to inflation outcomes.

The AI boom is not a cost-free boom. The surge in investment for data centers, hardware, and software carries with it much promise, but that surge also burdens resources. Electricity load demand is primed for sustained growth for the first time in a long time. We are therefore still due for further upward pressure on costs, and at a scale that is of macroeconomic significance. Given all of the other challenges to the US economic outlook, we hope lawmakers and policymakers take greater care in navigating this point of macroeconomic turbulence, uncertainty, and potential fragility.