For more than a year, every new inflation number seems to have caught observers by surprise. But in recent months the surprise has been from inflation data coming in lower than expected.
In the UK, the US and the eurozone, the latest inflation rate did not just fall but fell significantly below what was forecast. In the US, which led its peers into the inflationary episode of the past 20 months, price growth peaked in June; energy prices faced by American consumers have fallen outright since then. International prices for oil, gas and food commodities have also been declining sharply since the summer.
If such developments continue, that much-maligned label “transitory” will again be a tempting description of inflation. Price dynamics will have behaved just as one would have expected from the series of one-off relative price shocks the world has gone through.
These were the US consumer’s enormous swing towards buying goods, not services; supply chain disruptions from Shenzhen to Suez; the rise in food and energy prices in late 2021 — with hindsight, linked to Vladimir Putin’s slowing down of gas flows to Europe already then; and, of course, Russia’s assault on Ukraine and further weaponisation of the energy and food trade.
So we are nearing the time when the compound inflationary effects of one-off shocks wear off or go into reverse. That will be the hour of truth. It is only then, and provided there are no new shocks, that we will find out if self-sustaining price pressures have entrenched themselves — which is the premise for central banks’ continuing tightening.
Already the Federal Reserve projects headline inflation at only 3.1 per cent and the European Central Bank at 3.6 per cent in one year’s time. We cannot rule out that it drops even faster than foreseen. Central banks would then be tightening the screws on the economy to address yesterday’s problem, a year into a severe cost of living crisis and against sharply slowing jobs and income growth, if not recession.
Yet the Fed and the ECB have chosen this moment to signal a more hawkish stance, telling us last week to expect a higher “terminal rate” — the interest rate they intend to reach before they stop tightening. Shamed from being caught out by higher-than-expected inflation, central banks are courting the opposite risk, encouraged by many economists. Olivier Blanchard of the Peterson Institute has warned that falling headline inflation is a “false dawn”, so central banks “cannot relax”.
Why this fear of good news? On both sides of the Atlantic, hawks insist “core” inflation (excluding food and energy) remains too high. But consumers face the overall not the core price level. The claim must be that falling headline inflation will not bring core inflation down, even though rising headline inflation is what pulled core inflation up.
The reason given for such asymmetric pessimism is that wages are growing faster than in normal times, especially in the US. But central banks need to show they have also weighed arguments why this need not be inflationary, if they don’t want to be seen as thinking all wage growth is bad.
One is that if wages have risen in response to higher prices, they should also slow down as headline inflation falls. Another is that where the national income shares have shifted from wages to profits, companies have room to accommodate higher pay.
But the most important argument is that after the pandemic, we are in the uncharted waters of profound labour market restructuring. New research by economists David Autor, Arindrajit Dube and Annie McGrew shows how current US wage growth, strongest (and above inflation) for the low paid, reflects an accelerated rate of job-shifting. Pandemic disruption and support policies have meant many more people are finding new employers who can afford to pay them a higher wage.
This should matter enormously for monetary policy. Wage “inflation” due to people getting more productive jobs in more productive companies is surely not harmful inflation. Higher productivity should itself be disinflationary for prices. Yet this possibility seems far from the minds and certainly from the words of central bankers.
European labour markets may behave differently. But US financial conditions set the rhythm for the global economy, so any unnoticed disinflationary forces there will soon become relevant elsewhere too.
Central bankers are comfortable being seen as grinches. But from the gold standard era to today, they have also been accused of something worse: of always taking capital’s side in a distributive battle against the working class. They should be wary of proving their critics right.
