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What’s next for inflation

What’s next for inflation?


Many of the world’s most prominent monetary economists were wrong-footed by the emergence of inflation in mid-2021. United States Treasury Secretary Janet Yellen called the inflation risk “small” and “manageable”. Federal Reserve Chairman Jerome Powell said price rises would be “transitory”. Mohamed El-Erian has since called this the worst inflation call in the history of the Fed. 

Mainstream economists believed inflation was being driven by a combination of exceptional circumstances. Economies were just emerging from unprecedented lockdowns and the trend appeared to be driven by certain goods whose supply chains had been particularly disrupted. But as CPI inflation increased to over 7% in December 2021, it became clear there were broader factors at play. Jerome Powell began preparing the market for higher interest rates and the series of ongoing rate rises began in early 2022. 

Supply-side shock or overstimulated economy? 

Economists have since contested whether price rises were caused by excess demand or reduced supply. A speaker like Blackrock CEO Larry Fink argues the latter. He says that international supply chain issues were the primary cause of post-pandemic inflation. These issues were exacerbated by the Russian invasion of Ukraine in February 2022. Mark Zandi, chief economist at Moody’s analytics, concluded that, by May 2022, 3.5% of the 8.6% headline inflation rate was caused by this geopolitical shock. 

Other thinkers of a more fiscally conservative disposition have pointed to the overstimulation of the economy by government spending during the pandemic. Speakers like Tyler Cowen point to consistent inflation across sectors, an unlikely consequence of a squeeze on supply. These speakers are also likely to blame quantitative easing and the excessive increase in the money supply. They allege this caused an increase in demand without any corresponding increase in production. 

Structural or Transitory? 

The market anticipates that the Fed is now done raising rates and will hold at 5.5% at its next meeting. The recent rise in unemployment figures suggests the labour market is loosening and the prospect of any wage price spiral looking less likely. Inflation has eased to 3.3% and traders believe rate cuts may start again next May. 

But this expectation seems to assume inflationary pressures were temporary. Prominent economist, speaker and former Treasury Secretary Larry Summers recently posted uncomfortable comparisons between now and the 1970s. The graph he cited shows US inflation figures of the last 10 years almost exactly mirroring those from the mid 1960s to 70s. In 1976, just like 2023, inflation seemed to be coming under control but it subsequently increased rapidly and hit a high of 14% in 1979. Summers warns that parts of the US economy continue to run very hot and it is no time for the Fed to think about easing interest rates. 

Changing economic environment 

Governments’ responses to the pandemic and the Russian invasion of Ukraine have inevitably changed the economic status quo. The low interest rate environment we came to consider normal was quickly undone in the space of a few years. However, one may ask whether these major events accelerated underlying forces already at place. For instance, increasing geopolitical tensions, particularly between the US and China, meant that we were already moving away from what Francis Fukuayama so memorably called “The End of History”. The collapse of the Berlin Wall and China’s ascension to the World Trade Organisation heralded a period of unprecedented diplomacy. Globalisation was made possible by this peace and ensured that supply chains could operate in the most cost efficient jurisdictions. Those of us growing up in this period considered it normal but, historically, it was thoroughly abnormal. As the world returns to a more fractured state of affairs, we are likely to see more “nearshoring” as companies move their production lines to reliable neighbours, increasing security but forsaking cost efficiency, 

There are also major demand shocks on the horizon. Perhaps the biggest of these is the worldwide commitment to net zero. Mutterings of discontent are already beginning amongst certain populations as they come to realise the scale and cost of the infrastructure investment necessary to make this green transition. While the cost of greener sources of energy and production may diminish over time, the short term price pressure is forcibly upwards.

Increasingly, commentators and speakers like Stephen Shaw are also starting to recognise the problems of the world’s rapidly ageing demographics. Globally decreasing fertility rates will reduce the size of the global workforce and therefore increase the bargaining power of the working age population. However, this outcome looks more uncertain as we cannot predict how technological advances may change the future of work. Moreover, governments have bigger concerns regarding how these aged populations will be funded. 

US vs The World 

Finally, this outlook does not consider that different regions may end up in very different inflationary environments to others. Recent data shows that the US is taming inflation while Europe is not. Meanwhile China is more worried about deflation. But we can be certain that global factors are much changed from ten years ago and it would be foolish to assume we can return to that status quo.