An Optimistic Scenario for Inflation

One surefire indicator that an upcoming economic statistic is going to be politically troublesome is when the White House tries to get out ahead of it. That happened on Thursday, when President Biden warned that a Labor Department report on consumer-price inflation for November, to be released the following day, wouldn’t reflect a recent dip…

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One surefire indicator that an upcoming economic statistic is going to be politically troublesome is when the White House tries to get out ahead of it. That happened on Thursday, when President Biden warned that a Labor Department report on consumer-price inflation for November, to be released the following day, wouldn’t reflect a recent dip in gas prices. Sure enough, the report was an alarming one: it showed that prices rose by 6.8 per cent in the preceding twelve months—the biggest jump since 1982.

Inflation is now higher than virtually anyone predicted, and, over the past year, prices have risen faster than wages, which increased by 4.8 per cent. Add in that gas prices are roughly fifty-per-cent higher than a year ago and it’s not surprising that Biden’s economic approval ratings are lagging—despite a healthy growth in employment and household incomes. In a statement on Friday, the President pointed out that the economy has created nearly six million jobs over the past year, and that new unemployment claims have recently fallen to their lowest level in a half century. Moreover, there is an important caveat to the news about wages. For many workers at the bottom of the income ladder—that is, the ones who need a pay raise the most—wages have risen faster than prices. In the leisure-and-hospitality industry, between November, 2020, and November, 2021, average hourly wages went from $14.70 to $16.67. That’s a jump of more than thirteen per cent, or roughly six per cent after inflation. After decades of wage stagnation for these low-wage workers, this represents a dramatic change.

The key thing now—for the economy and for the political prospects of Biden and the Democrats—is whether the inflation rise turns out to be temporary or permanent. The Fed chairman, Jerome Powell, saying in a statement last week that it is “probably a good time to retire” the term “transitory” regarding inflation added to concerns that a longer-term problem may be afoot. However, Friday’s inflation report shows that the data are broadly consistent with Powell’s prior argument that dynamics related to the pandemic and the resulting global supply-chain problems are driving most of the surge in prices, and that inflation should fall back in 2022 if those issues get resolved. At least one economic forecaster believes that by next November—the month of the midterms—the headline inflation rate will have fallen to below two per cent.

That forecaster is the consulting firm Oxford Economics. After Friday’s report was released, I spoke with Gregory Daco, the firm’s chief U.S. economist, who said the report showed the same trends that have been evident for months: strong upward pressure on the price of physical goods, many of which depend on far-flung supply chains, and significant but smaller price rises for services, which have been less affected by pandemic-related disruptions. On a seasonally adjusted basis, the prices of new vehicles increased by 1.1 per cent between October and November, and the cost of used vehicles rose 2.5 per cent. Energy prices rose by 3.5 per cent, with the biggest increases coming in gasoline and fuel oil. By contrast, the price of non-energy services increased by 0.4 per cent, the same increase as in the previous month. “If you look out to next year, twelve months from now, you are likely going to see much lower goods-price inflation and somewhat higher services-price inflation,” Daco said. “But, on net, you will see substantially lower inflation.”

Echoing Biden’s point about gas prices, Daco also predicted that the headline inflation rate would start to fall as early as this month. Since the end of October, the price of crude oil has dropped by more than ten dollars a barrel on world markets, which is now resulting in slightly lower prices at the pump. According to A.A.A., the average price of gasoline nationwide is $3.34 a gallon, compared with $3.42 a month ago. “In the December inflation report, you are going to see disinflation in energy prices,” Daco said. “We think the peak in the headline rate of inflation is now.” By February, Oxford Economics forecasts, the inflation rate will edge down to 6.3 per cent. In June, it will be 4.1 per cent, and in November, 1.9 per cent. The forecast shows the “core” inflation rate, which excludes volatile energy and food prices, moving in the same direction, though a bit more slowly. It peaks in February at 5.2 per cent, before falling to 3.2 per cent in June and 2.2 per cent in November.

This is only a prediction, of course, and it might prove overly optimistic. In a Twitter post on Friday, another Wall Street prognosticator, Ian Shepherdson, the chief U.S. economist at Pantheon Macroeconomics, warned that core inflation could reach as high as seven per cent over the next few months. But Shepherdson, like Daco, also raised the possibility that falling gas prices may mean the headline rate has already peaked. In a recent note to clients, Shepherdson said that inflation should abate considerably further into 2022, as some problems with the supply chain are resolved and productivity rises, a point he reaffirmed to me on Friday. “If we’re right about all of this,” he wrote, “core PCE inflation”—another measure, which the Fed watches closely—“should end next year below 3%, and falling.”

Biden and the Democrats will be hoping fervently that these predictions prove accurate. If they do, and if the Fed manages to alter course without precipitating a financial crash, the White House could go into the midterms pointing to a historic recovery from the pandemic, higher wages for frontline workers, and an inflation threat that is receding. To be sure, this scenario involves big ifs. When I asked Daco what would make him reconsider his benign inflation forecast, he pointed to two dangers: a sharp rise in inflation expectations or a further pickup in wage growth. If both these things occurred simultaneously, they could generate a damaging wage-price spiral. So far, Daco insisted, he hasn’t seen persuasive evidence of either. “Let’s see what wage growth is six months from today,” he said. “I wouldn’t be surprised if by the spring it is starting to edge down.” With the Omicron variant adding another unpredictable variable to the economic equation, only the passage of time will tell us whether his optimism is justified. Right now, for Biden and the Democrats, six months seems a long time away.


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