Inflation may be falling, not accelerating

Global inflation updates

This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Sign up here to get the newsletter sent straight to your inbox every Thursday

There is one big economic question that is currently drowning out most other debates: whether inflation is getting out of control and, if so, whether governments and central banks need to step on the brakes promptly.

The numbers published in news headlines certainly look worrying. Here is what year-on-year growth in the consumer price index looks like in the US:

and in the eurozone, where the annual inflation measure (HICP) has reached a 10-year high:

Chart showing the eurozone’s harmonised index of consumer prices from 1997 to 2021

There is, however, a problem with these charts and headlines: they obscure that inflation is in fact slowing.

In normal times, year-on-year price growth is a pretty good measure of inflation trends, since it is unaffected by seasonal swings (think seaside hotel room prices in holiday season), and inflationary forces do not change that fast. But the pandemic has turned our economies topsy-turvy. Supply, demand and the prices that are shaped by them are changing so fast that a one-year difference in price levels is a poor guide to how prices are moving right now. For example, prices could be much higher today than a year ago — and yet be falling fast today (this happened for US CPI in November 2020 and to eurozone HICP in July 2021).

In times like these, it is more informative to look at instantaneous price inflation — the month-on-month change in prices. To avoid the seasonal problem (those holiday hotel rooms), we can use the monthly percentage change in the seasonally adjusted price index. This is what that looks like in the US for the CPI, which in July grew at the slowest rate since February:

Chart showing change in CPI inflation

The deceleration is even clearer when looking at the Personal Consumption Expenditures index, which US central bankers favour over the CPI:

Chart showing the US Personal Consumption Expenditures index, month-on-month percentage change

On this measure, which is the one Federal Reserve interest-setters target, inflation has been falling every month for four months, again to its lowest level since February.

These levels are still high, to be sure — if sustained for a year, they would accumulate to annual inflation of 5 to 6 per cent. The point is simply that they are the lowest they have been in months. Keep that in mind when you see those year-on-year price changes accelerating — they say more about what happened last year than what is happening now.

Such a pattern can be seen in the eurozone too, although it is weaker there. Look at the chart of the monthly percentage change in the seasonally adjusted version of the official price index targeted by the European Central Bank (the same as the one charted as year-on-year changes above):

Chart showing seasonlly adjusted Harmonised Index of Consumer Prices, month-on-month percentage change

Inflation actually fell to almost-normal levels last month. A measure of core inflation, which excludes volatile food and energy prices, is even more subdued on a monthly basis — apart from a few single-month rises, inflation has behaved just like before the pandemic.

Chart of seasonally adjusted Harmonised Index of Consumer Prices excluding food and energy, month-on-month percentage change

These simple graphs do not resolve the argument. Inflation could still become unmoored. But it would make for a better debate if we recognised the fact that, at the moment at least, inflation looks like it is slowing.

It could get better still if we pondered why it is slowing. I wrote a few months ago that if price pressures were driven by bottlenecks, we should see the economy as a ketchup bottle from which “none will come/and then a lot’ll” as Richard Armour put it. It could simply be that we are already moving from the “none” to the “lot’ll” phase of the ketchup-bottle economy.

In a recent blog post, the White House Council of Economic Advisers’ Jared Bernstein and Ernie Tedeschi highlight that a lot of disinflationary forces loom over the US economy. The expansionary effect of budget policies depends on the change in the deficit (or surplus), not its level, so as the enormous pandemic spending recedes, the economy will be slowed down by fiscal policy even if the deficit remains large. And they point out that the infrastructure and training and educational investments their administration is pushing for should increase productivity over time and thereby dissipate price pressures as supply capacity expands to satisfy demand.

Whatever happens to the Biden administration’s infrastructure proposals, I think we may be seeing such disinflationary productivity effects already in play. In my FT column this week, I argued that we should welcome the labour shortages we are seeing as harbingers of a productivity boom. A case in point: my colleague Taylor Nicole Rogers’ story on how US retailers are using QR codes to automate work previously done by shop assistants. As the chart below shows, OECD forecasts show labour productivity accelerating in virtually all the biggest high-income economies in the three years spanning the whole pandemic (both the collapse and the rebound) compared with the three years preceding it.

Chart of three-year growth in output per hour worked

If this is borne out, it should help keep inflation at bay and bring better-paid jobs in the bargain. These are early days and that hope could prove unrealistic. But to balance out the doom-mongering, let us not ignore the very pleasant surprises the post-pandemic recovery is presenting us with.

Other readables

  • All the presentations from last week’s Jackson Hole symposium are now available online. My colleague Robert Armstrong’s markets newsletter Unhedged (which I strongly advise you to subscribe) has covered one particularly interesting paper on how inequality affects long-term interest rates.

  • I stood in for my colleague Gideon Rachman in his podcast on global politics, for which I interviewed Sarah Chayes on what went wrong in Afghanistan and what it says about the US’s own problems at home.

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