This week three important inflation reports. On Monday, the Federal Reserve Bank of New York released its latest survey of expectations for rising prices, which was very encouraging. On Wednesday, the Bureau of Labor Statistics released its latest report on producer prices, and it’s been pretty reassuring. However, the interim document – Tuesday’s bad one on consumer prices – has grabbed most of the attention.
And, look, I get it. After the benevolent report on last month’s consumer prices, some people—among them, it seemed, a few investors—had begun to hope for a fairy-tale ending to rising inflation in 2021-2022. This month’s document has largely dashed those hopes (which, by the way, long time no share).
In any case, it is important to understand what the report showed and what it did not. If they still believed that we could bring inflation down to an acceptable level without pain—namely, without a rise in the unemployment rate—Tuesday’s data has made that belief harder to sustain than it already was. Unfortunately, there will be pain. However, the report gave little indication, one way or the other, of how much pain will be needed or how long it will have to last.
Economists often analyze these questions based on what is happening to underlying or “core” inflation, and then debate what is the best measure to use to measure it, to the bewilderment of the rest. That’s why I really liked economist Joseph Politano’s alternative formulation, which proposes that we distinguish between “immaculate disinflation”—a decline in inflation rates that will take place more or less automatically when the recent disruptions caused by the pandemic subside, the war in the Ukraine, etc. – and “deliberate disinflation”, which is what the Federal Reserve tries to produce reducing interest rates.
And, things as they are, it is very likely that “deliberate disinflation” lead to job losses. Since the Fed’s rate hikes are intended to reduce global spending, they will almost certainly lead to more unemployment.
Now, “immaculate disinflation” is not a myth; in fact, it has been going on lately. Headline consumer price inflation measured in months slowed considerably this summer, largely as gasoline prices stopped rising and started to fall.
But, if we look behind the figures, it is clear that “immaculate disinflation” will not be enough. I would like to believe the opposite; in fact, a year ago, I thought the price hike might largely heal itself. However, whichever measure you prefer, at this point core inflation —which won’t go away on its own— is still too high, and shows no clear signs of going down.
Although this revelation has apparently shocked the financial markets, it should not have come as much of a surprise. Although interest rates have risen a lot this year, they have not yet had much of an impact on the real economy. As much as it is said that we are in a recession, the fact is that unemployment is still practically at an all-time low, and other measures, such as the number of job openings, indicate that the economy in general and the labor market in particular are still overheated . And we’re not going to get inflation down to an acceptable rate until things cool down. However, precisely because no significant cooling has occurred, the latest figures do not tell us how painful the disinflation process is going to be.
An optimistic scenario could be the following: the Federal Reserve rate hike causes the unemployment rate to increase, but only by around 4%, which is still quite low by historical levels, and that is enough for the inflation down to 2% or 3%. The odds of this scenario are improved by considering the evidence—such as the New York Federal Reserve report I referred to—that 2022 is not like 1980. Back then, everyone thought high inflation was going to persist, so the economy had to be passed through a sieve in order to exclude those forecasts. Recent expectations, especially in the medium term, have been low and are on the decline.
Pessimists, however, argue that the high rate of job vacancies means that much more unemployment is needed to control rising prices than in the past; and (for reasons I don’t quite understand) they dismiss the good news about expectations. For this reason, they end up maintaining that unemployment will have to increase much more, perhaps above 6%.
As you can imagine, I lean towards the optimistic scenario. I take the data on expectations seriously and believe that the high job-fill rates are, at least in part, a temporary phenomenon in an economy that is still adjusting to the effects of the covid-19 pandemic. But the truth is, no one knows for sure, and the fact that an overheated economy continues to result in high inflation doesn’t help settle the debate.
The good news is that the Federal Reserve seems to know what it doesn’t. It speaks harshly about inflation, as it should to maintain its credibility, but it also affirms that it is necessary to look at “all the data that arrives”, which means that it is prepared to relax measures when there is a clear drop in the inflation, if it occurs. What I foresee is that this moment will come sooner than many think, but we will have to wait and see.
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