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January 15, 2024



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Macro Research Bites #4: Arguments Against Persistent Inflation

This post is the fourth in our Macro Research Bites series, which breaks down evolving macroeconomic trends into short, digestible pieces. Each post will also exist in thread form, shared on Twitter/X. In this article we tackle the topic of inflation, specifically making the argument against persistent inflation, supported by data. Our following post will explore the alternative view, leaving you to decide for yourself what you believe.

For the first time since the 1970/80s, inflation has reared its ugly head. Rapidly rising prices have left many shellshocked, questioning whether we’re in for a repeat of that time period’s stubborn, double-digit inflation – or whether this time is different, with the worst behind us.

There are compelling arguments to support both views. While expectations are largely that inflation has retreated, last week's December CPI print, which came in hotter than expected, has some questioning that assumption. Let’s start with optimism, however: here’s the case for declining inflation and better days ahead.

First, some context

The Consumer Price Index (CPI) is defined as a “measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services” (BLS) on about 80,000 items. The Personal Consumption Expenditures (PCE) price index, a more comprehensive measure, is the Fed’s preferred. CPI tends to narrowly come in higher than PCE.

The Fed divides CPI inflation into ‘sticky’ and ‘flexible’ inflation. Sticky goods are those that take > 4.3 months to change price e.g. housing, medical etc while flexible is categorized as those that change in < 4.3 months e.g. food, fuel etc.

Sticky or persistent inflation is the focus of central banks and inflation watchers worldwide. As you can see from the red line above, sticky inflation is still, well… sticky, and the stickiest it has been since the 1970/80s.

But will it stay sticky?

To answer that question, let’s look into the some of the commonly agreed drivers of the post-pandemic bout of inflation as covered by ex-Fed Chair Ben Bernanke and his colleague here:

- Supply chain disruptions

- Significant fiscal support

- Pent up demand from re-opening

- Russia-Ukraine war driving up global energy prices

Supply chain disruptions

Pandemic lockdowns caused untold chaos across supply chains but data suggests we are back to pre-pandemic levels. The NY Fed developed the Global Supply Chain Pressure Index to provide a comprehensive summary of the health of global supply chains including data from the Baltic Dry Index (BDI) and the Harpex index, as well as airfreight cost indices from the U.S. Bureau of Labor Statistics. The GSCPI also uses several supply chain-related components from Purchasing Managers’ Index (PMI) surveys.

Supply chain disruptions have since abated and returned largely to pre-pandemic levels.

Significant fiscal support

Findings from the Fed suggest that fiscal stimulus contributed to an increase in inflation of about 2.5 percentage points. Fiscal programs from the Biden regime included:

- Dec 2020 $900 billion for covid relief

- March 2021 $1.9 trillion American Rescue Plan

These came on top the March 2020 $2.2 trillion CARES Act passed by Trump.

Since the pandemic's peak in 2021, no significant fiscal support has been passed. The helicopter money days are unfortunately over (for now).

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Pent up demand from reopening

Generous fiscal support coupled with a tight labour market and fractured supply chains led to massive pent up demand from consumers, leading to the third, related inflation cause under this framework.

Savings rates for consumers skyrocketed first before being followed by Personal Consumption Expenditures (PCE), which measure how much money Americans are spending on goods and services. Data below suggests that as savings rates have fallen back to pre-pandemic levels, spending and retail sales have also normalised.

Russia-Ukraine war driving up global energy prices

On 24 February 2022, Russia invaded Ukraine, sending global energy prices soaring. Since, however, prices have stabilized, as can be seen in the energy and commodity prices section of the latest CPI release.

This situation is echoed in Europe as it moves further from reliance on Russian energy.

While the data are encouraging, an as-yet unresolved Russia-Ukraine war and rising geopolitical tensions in the Middle East may lead to renewed disruptions to energy supply and downstream effects on price. It seems too early to conclude definitive victory over energy price instability.

Inflation (may be) over

We looked at four of the primary drivers of inflation, precipitated by the pandemic and government and consumer responses. Our analysis suggests that three of the four main drivers have already abated, returning fully to pre-covid norms. The main uncertainty in the context of our analysis is the effects of the Russia-Ukraine war on energy prices. Despite recent price normalization, it seems naive to dismiss this risk entirely given the ongoing conflict and rising tensions in the Middle East. In our next piece, we’ll do our best to counter our own argument and make the case for persistently higher inflation being here to stay.

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