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The U.S. Department of Labor announced July inflation data on August 11. In July, the CPI fell slightly month-on-month to 8.5% year-on-year, a significant drop from 9.1% in June.
U.S. economy: Inflation inflection point emerges
Energy prices fell significantly in July, which was the main reason for the decline in inflation. The core CPI, excluding food and energy, increased by 0.3% month-on-month, a significant decrease from the previous month and the average level of the first three months; it was 5.9% year-on-year, unchanged from the previous month, and the high point of the core CPI was 6.4 in March 2022. %, although there has been a downward trend, the downward trend is relatively slow. Since the market had already expected a decline in CPI (for example, the decline in oil prices was obvious), the US stock market rose significantly throughout July.
The U.S. Bureau of Economic Research released data on U.S. households on August 26, which provided more signals on income spending and inflation. Resident income increased by 0.2% month-on-month in July, the lowest level since January 2022, and a significant slowdown from the growth rate of previous months (a three-month average of more than 0.5%). Household consumption expenditure increased by 0.1% month-on-month, the slowest growth rate since January 2022, and a sharp drop (0.65%) from the average level of the previous three months. The slowdown in expenditure growth is a good signal for controlling inflation. . The PCE price index decreased by 0.1% month-on-month and 6.3% year-on-year, both of which were significantly lower than the previous month, and both were the lowest levels in the past five months. The core PCE price index excluding food and energy increased slightly by 0.1% month-on-month and 4.6% year-on-year, both of which were significantly lower than the previous month.
The just-released August non-farm payrolls data showed that 315,000 new jobs were created, down significantly from 530,000 in July, but still relatively strong. Hourly wages grew by 0.3% month-on-month, the slowest pace in the past six months, again showing that the wage inflation spiral is not taking shape. The growth rate of hourly wages was 5.2% year-on-year, basically unchanged from previous months. The most interesting change came from the unemployment rate, which rose to 3.7% from 3.5% in the previous month, although employment continued to increase, due to an increase in the willingness to work, with the labor force participation rate in August from 62.1% in July It rose slightly to 62.4%. Around 2000, the labor force participation rate in the United States reached a historical high of 67%, and has gradually declined to around 63% in the past 20 years. If some structural changes can trend upward in the labor force participation rate, this would provide additional favorable conditions for inflation to ease and economic growth to grow.
If you look at inflation and unemployment, the economy is still overheated. It should be noted, however, that non-farm employment in July has just reached the level of February 2020 before the epidemic. And this level of employment, which few economists considered at the time to be full employment, underscores the unusualness of this round of inflation. In another article published in this issue, I argue that the high speed of economic recovery has brought about this high inflation, not because actual output has exceeded potential output. Based on this judgment, I think that if the economic growth rate is slowed down, inflation can be reduced, and a recession can be avoided at the same time.
The nominal GDP growth rate of the United States in the second quarter was 8.4% year-on-year, which was a significant rebound from 6.6% in the first quarter, but this mainly reflected the impact of supply shocks on prices after the Russian-Ukrainian war. The year-on-year growth rate of nominal GDP in the second quarter was 10.1%, down from 11.4% in the first quarter. The real GDP growth rate in the second quarter was negative 0.6% year-on-year, compared with negative 1.6% in the first quarter.
As monetary policy continues to tighten, there is reason to believe that aggregate demand will continue to fall, which will lead to a further fall in inflation, and in the absence of a major shock, the labor market, if weak, will not deteriorate significantly. Although the quarterly real GDP growth rate is already in the negative growth range, the year-on-year growth rate is still likely to be positive. This appears to be the trajectory of an economic soft landing, although a soft landing is generally considered a narrow path.
The Fed’s rhetoric
Every summer, global central bankers and leading monetary theorists and financial journalists gather in the small town of Jackson Hole, Wyoming, USA, to discuss the most pressing issues of the global economy and monetary policy. In a widely anticipated speech on August 26, Fed Chairman Powell made a speech that the current federal interest rate in the range of 2.25-2.5% is already a long-term neutral level. At the same time, he believes that considering the current economic conditions, interest rate hikes cannot stop here. Of course, this is not surprising, and no one thinks that the rate hike cycle will stop there. However, Powell’s speech based on history made people feel a heavy atmosphere. He touched on three historical lessons, all set against the backdrop of the hyperinflationary period of the 1970s and early 1980s. The first is that the central bank cannot shirk its responsibility for controlling inflation. The central bank can and should control inflation. The second is to emphasize the impact of persistent high inflation on public inflation expectations, and point out that high inflation expectations will increase the cost of controlling inflation. The third is that inflation cannot be relentless, and there must be a determination not to give up until the target level is reached.
Data showed that U.S. inflation was already on a downward trend, and Powell did not address these favorable developments in his speech. His tone was solemn, taking stagflation as a lesson, and he seemed determined to overdo it. Among the three lessons, he talks about inflation expectations the most. His core view is that the longer the high inflation lasts, the more likely it is that the public will form high inflation expectations, so time is tight. Following this logic, Powell would not only want to see a downturn in inflation, but possibly a rapid decline in inflation as well. This means that policy rates need to be pushed up quickly to highly deflationary levels, thereby rapidly reducing aggregate demand and, consequently, inflation. This implication made the market react strongly, the US treasury bond interest rates rebounded significantly, while the stock market continued to fall.
The risk of the Fed overcorrecting
Ahead of October 2021, the Fed has been dovish on inflation and more talking about labor market deficiencies, especially stressing that minority employment is not yet satisfactory. Even if inflation is already high in the fourth quarter of 2021, the Fed has still not raised policy rates, and the first rate hike will be in March next year. Looking back, this was indeed too “dive”. After March 2022, interest rates will be raised sharply in May, June, and July in a row. The Fed has shifted from a job-inflation-oriented stance to an inflation-first stance, and its attitude has become increasingly hawkish. However, if it asks too much about the speed of inflation, the Fed could make two mistakes in the same inflation cycle: too indecisive during the inflation phase and overcorrection during the high inflation phase.
It makes sense for Powell to take history as a guide, but if you don’t “immerse yourself” in the stagflation of the 1970s, but simply believe that continued inflation will push up inflation expectations, you may be making a big mistake. Born in 1953, Powell experienced stagflation in his youth. However, I don’t think he could be able to feel the various forces formed by stagflation at that time, just as Trump was familiar with various things such as weddings, funerals, fashion receptions, etc. in the United States, but he did not necessarily understand the United States. The current wage growth rate is not high, and the public has a clear explanation for the high inflation: a lot of relief was given during the previous epidemic, the generous relief funds and the epidemic led to fewer people willing to work, and although the Russian-Ukrainian war pushed up the increase Energy prices, the United States is not at war. In my opinion, all these factors prevent the public from having persistent inflation expectations. Only those who do not understand, hazy, but prices have been rising, the public will form inflation expectations. Let’s briefly review what happened in the 1970s.
The stagflation of the 1970s, as well as persistent inflation expectations, was formed by the superposition of many episodic but far-reaching events. In the early 1970s, when the United States was mired in the Vietnam War, with unprecedented budget deficits (though not high by today’s standards), and wars often led to inflation, it was natural for people to lose faith in price control. The Nixon administration instituted wage price controls in 1971, which disrupted the price mechanism and led to a loss of confidence in the government’s ability to control inflation. The deteriorating balance of payments in the United States made it difficult to maintain the gold standard. The U.S. government stopped the exchange commitment of the dollar and gold in 1971, and officially ended the gold standard in 1973. The world monetary system was decoupled from gold and entered an era of highly uncertain floating exchange rates. The OPEC oil embargo that started in October 1973 tripled the price of oil in a short period of time (the Iranian Revolution of 1979 and the subsequent Iran-Iraq war doubled the price of oil again in a short period of time). Finally, Nixon’s nomination of Fed Chairman Burns was too succumbed to the pressure of the government, and the tightening monetary policy was repeatedly abandoned halfway. At that time, the Federal Reserve’s misunderstanding of the causes of inflation and the shirk of various departments of the federal government on the responsibility of controlling inflation led to the imbalance of macro policy. When all these things are listed, it seems clear that the stagflation of the 1970s was caused by the simultaneous occurrence of a number of accidental and far-reaching events. Compared with the present, I think the conditions for the formation of persistently high inflation expectations are far from being formed.
Keynes developed the theory of aggregate supply and aggregate demand, which is of course different from the highly formalized models in later textbooks. Its effective demand is a total amount, and the increase in effective demand will be reflected partly in price and partly in output. The stagflation of the economy later led economists to consider price expectations, which means that people may “raise prices out of thin air”, such as at each output employment level, all contracts are 10% higher because of price expectations. This is indeed something Keynes did not analyze. But even with so many models, it’s hard to imagine how this mechanism would work. Putting aside the complexity of the theory, assuming that there is indeed an expected factor in the price change of the economy, that is, a coordinated collective price increase, then at least one link is still missing, that is, the price increase of wages. Wages are currently rising well below prices, and compensation is not in sight to rise. This leads me to believe that inflation expectations that lead to simultaneous price increases in all contracts are far from being formed, which is also consistent with the stable inflation expectations implicit in current financial market contracts.
In the absence of high inflation expectations, and it is difficult to form in the future, it may be overkill to tighten rapidly based on the current high inflation.
Note: The author is a doctor of economics, a financial practitioner This article only represents the author’s personal views
This article is edited by Xu Jin [email protected]