Will the recession crush inflation? What the Economist says
Not even a global recession could be enough to bring down the inflation rate: here's why. The deepening of the Economist
Investors welcomed the good news enthusiastically. European equities have rallied since early October, with optimists declaring the end of the continent's energy crisis in sight. Chinese stocks rose on recent rumors that Xi Jinping will abandon his "zero covid" policy, and as regulators eased restrictions on real estate.
On November 10, on news that consumer price inflation in America fell slightly below economists' expectations, the Nasdaq index, which is based on the technology sector, rose 7%, one of the largest daily moves ever , as investors expected a decline in interest rates.
But if we take a step back, the outlook for the global economy has actually darkened in recent weeks. The economy is slowing, possibly to a recession, as central banks raise interest rates to counter a once-in-a-generation price hike.
Even with a month of better-than-expected data for America, there's little evidence that inflation is nearly dead. Indeed, much of the world is expanding – writes The Economist .
For most of this year the world has feared a recession. Google searches for “recession” neared a record in June. But for a long time, gloomy rhetoric overtook reality. From the end of 2021 to the third quarter of this year, the average rich country's output increased by about 1.3% – unspectacular growth, but not a negative one. In the year to September, the average unemployment rate in the OECD, a club of predominantly wealthy countries that accounts for about 60% of world GDP, fell by nearly one percentage point. Unemployment in the euro area has reached an all-time low. Consumer spending has been strong, with hotels, planes and restaurants crowded around the world.
Now reality has caught up with rhetoric. The increase in the cost of loans is starting to make itself felt. In many countries, including Canada and New Zealand, home prices are falling as buyers face increasingly expensive mortgages. Homebuilders are canceling construction projects and homeowners are feeling less wealthy. Other companies are also cutting expenses. In their latest report on monetary policy, researchers at the Bank of England note that rising funding prices "weigh on investment intentions". The minutes of a recent Federal Reserve meeting note that business fixed investment has "already begun to respond to tightening financial conditions."
Deteriorating economic conditions are starting to show up in “real-time” data. Goldman Sachs bank publishes a "current activity gauge," a month-by-month measure of economic strength. Last month, for the first time since the initial Covid-19 lockdown in 2020, economies across the rich world appeared to be contracting. Similarly, a global survey of purchasing managers points to a contraction for the first time since June 2020. Since July, a "nowcast" of annualized global GDP growth produced by JPMorgan Chase, another bank, has halved.
Optimists point to the strength of labor markets. America's formidable job machine has slowed, but it keeps turning, adding more than 250,000 jobs in October. Elsewhere, however, signs of weakness are emerging. Economist Claudia Sahm has suggested that a recession is near when the average unemployment rate over the past three months increases by at least 0.5 percentage points from the previous year's low. We find that eight of the 31 rich countries currently meet this criterion, including Denmark and the Netherlands. This is not a high percentage compared, for example, at the onset of the global financial crisis of 2007-2009. But it signals that a serious slowdown is underway.
High prices to pay
The "Sahm rule" reveals another important truth: different countries move at different speeds. Aside from America, some places, like Australia and Spain, are still growing decently. Others, however, are in trouble. Sweden, where high interest rates are hurting a particularly buoyant housing market, is fading fast. Britain is now almost certainly in a recession. In Germany, high energy prices are forcing industries to shut down. It may be the worst off country of all the rich countries.
How bad will the recession be? Households in rich countries still have trillions of dollars in “excess savings” built up in 2020-21 thanks to stimulus checks and other fiscal aid. This money will allow them to continue spending, even as real incomes decline. A large private-sector savings glut is associated with less severe recessions, and healthy savings means economic pain is less likely to translate into financial hardship, according to new research from Goldman Sachs. Mortgage delinquency rates are declining in America and are extremely low in New Zealand and Canada.
Labor markets are weakening, but a rise in unemployment like that seen after the financial crisis is unlikely. This is due to the fact that the demand for labor still has to fall far before it matches the supply. Earlier this year the two were seriously out of sync, with the number of unfilled vacancies across the OECD reaching a peak of 30 million, according to our calculations. Now, with declining demand, it seems that job vacancies are once again paying the price. According to our estimates, the number of vacant positions has dropped by a tenth from the peak, while the number of filled positions has remained unchanged.
Much depends, however, on the path of inflation. Central banks are willing to cause a recession to reduce inflation. The rate hike could lead to “some easing of labor market conditions,” as Fed chair Jerome Powell noted earlier this month. “We think [the rate hike] will dampen demand, we won't pretend it's painless,” warned the European Central Bank's Philip Lane. Both economic theory and data from the past seven decades suggest that the decline in GDP is associated with a large decrease in the rate of price increases. But the lags between tightening monetary policy and reducing inflation are not well understood. Central banks may be forced to suffer more than currently anticipated.
In some countries, lower energy and food prices are helping to bring down the global inflation rate. Recent US data for October was better than economists' expectations. In general, however, prices are not going in the direction central bankers want. Inflation “surprises” across the rich world, when data releases are higher than forecasts, are still frequent (see chart 4). According to data released on Nov. 16, inflation in Britain was 11.1% in October, higher than economists' expectations. Almost everywhere core inflation, which better reflects the underlying pressure on prices, is on the rise. In three dimensions – breadth, wages and expectations – inflation around the world is becoming more, not less, entrenched.
Let's start with the breadth. When the inflationary spike began last year, it was limited to a small number of goods and services in most countries. In America, these were used cars. In Japan it was food. In Europe it was energy. This provided false comfort to pundits, many of whom assumed that once prices stopped rising in these few components, headline inflation would peter out.
In reality, the inflation virus has spread. We analyzed consumer baskets in 36 mostly wealthy countries. In June, 60% of prices in the median basket were up more than 4% year-on-year. Now it is 67%. Even in Japan, the country of low inflation, the prices of a third of the basket rise by more than 4%. This enlargement is partly due to an exceptionally strong dollar, which is driving up inflation by making imports more expensive. But it has more to do with what is happening in national economies.
This is where the second dimension, that of wages, comes into play. Wages provide insight into the future path of inflation: when firms' labor costs rise, they pass it on to customers in the form of higher prices. Inflation optimists point to data out of America, where wages are noting a slowdown, albeit in the face of increases of 6% or more year-on-year. In Great Britain too, growth appears to have stopped at a high rate but is no longer growing.
Elsewhere, however, there is not much evidence of containment. New research by Pawel Adrjan of Indeed, a job posting website, and Reamonn Lydon of the Central Bank of Ireland suggests nominal wages in eurozone job postings are rising by more than 5% year on year and they are still accelerating. According to JPMorgan, French wage inflation "still has to grow." In Germany, ig Metall, the large union of metallurgical and engineering workers, is calling for a wage increase of up to 8%. In New Zealand, Norway and Sweden wage growth is still picking up. Not what one would expect at a time when the economic outlook is dire.
The third dimension is that of expectations. Alternative consulting firm Macro Signals analyzes millions of news articles in different languages through a model to construct a “news inflation pressure index”. The index, which has proven to be a good predictor of official numbers, is still high. Similar evidence comes from Google research data, which suggests that global interest in inflation has never been higher.
Survey-based measures of expectations also provide no evidence of a decline in inflation. Data compiled by the Cleveland Fed, data firm Morning Consult and Raphael Schoenle of Brandeis University measure public inflation expectations in various rich countries. According to the October survey, public opinion in the median country believes that prices will increase by 5% in the coming year, as in previous months. The inflation expectations of firms – the economic actors who actually set prices – are equally worrying. A Cleveland Fed survey, based on research by three economists, Bernardo Candia, Olivier Coibion and Yuriy Gorodnichenko, finds that American businesses currently expect 7% inflation next year, the highest level since the survey began in 2018.
Painful ignorance
Everyone can agree on one thing about the past year. It revealed how little economists understand inflation, including its causes and persistence. Economists are therefore also likely to struggle to predict when inflation will ease. Optimists hope that prices will once again surprise citizens, slowing their growth sooner than expected. But it seems more likely that inflation will prove stubborn even as the economy slows. That will leave policy makers faced with a grim choice: tighten the economy further or let prices soar.
(Excerpt from the press release of eprcommunication)
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/recessione-inflazione-2/ on Sat, 19 Nov 2022 06:41:35 +0000.