The United States is heading for stagnation, not stagflation
In a Project Syndicate article published in August 2021, my friend and former US Treasury colleague Nouriel “Dr Doom” Roubini, lucidly wrote that “the threat of stagflation is real”. Roubini’s argument was that those who think inflationary pressures and growth problems in the United States are largely due to temporary supply bottlenecks are doomed optimists. He makes well-founded arguments and may be right. But my bet for the 2020s is on stagnation, not stagflation.
Before the pandemic, I touched on the global economic outlook for the 2020s in an OMFIF commentary. I imagined a bad prospect, bordering on stagnation. Japan and Europe would remain in a slump of weak and deflationary growth; the United States could recover slightly but potential growth would be less than 2%; and Chinese growth would collapse sharply against the backdrop of demographic trends, anti-leverage, and a consumer and service society moving away from its inefficient and investment-intensive model. Emerging markets, which often rely on strong global growth to fuel commodity prices and exports, would face challenges.
But does the pandemic mean the world will experience stagflation rather than stagnation for the rest of the 2020s?
‘Stag’ remains firmly established. The pandemic has hit economies hard. They recover at varying speeds. Despite considerable macroeconomic stimulus, many are unlikely to return to pre-pandemic trends anytime soon, let alone recover from 2020 losses. The Delta Covid-19 variant will complicate recovery. Policy makers will soon adopt less ambitious macroeconomic positions. China is experiencing financial strains amid President Xi Jinping’s crackdown on the private sector and the fight against excessive debt. The financial difficulties of Chinese real estate giant Evergrande are a symptom of this. The outlook for emerging markets will only get tougher given weakening commodity prices, limited fiscal space, subdued global growth and squeezing monetary accommodations. Debt tensions abound.
But could the pandemic accelerate digitization, artificial intelligence and climate investments, boost productivity and put the world on a higher growth path? The technological changes brought about by the pandemic will change the future of work, but sustainable productivity gains require strong demand. In the post-pandemic environment, employers will produce more with fewer workers and reward capital at the expense of labor. New technologies need time to infiltrate everyday economic life. The rhetoric around climate goes far beyond action – humanity, alas, may well lose the race against time.
What about the “flation”? Here, the crystal ball is cloudier.
Roubini’s article sees supply chain disruptions lasting longer than many realize. That may be true, especially for the next two years. But supply chain disruptions are expected to start to subside thereafter. Building new chip plants can take time, but they will be. Consumer demand is likely to shift more from durable consumer goods and producer goods to services.
Many analysts point to de-globalization due to trade tensions and supply chain disruptions. But the pre-pandemic tensions between the United States and China were not causing inflation expectations to de-anchor. Supply chains were already on the move with production moving often, for example to Vietnam, closer to home and even some relocations.
In light of the strong fiscal stimulus in the United States, aggregate demand exceeds aggregate supply and spending supported by excess savings could support cyclical growth for some time. But budget support will decrease considerably and excess savings will be reduced.
Inflation will remain high relative to inflation targets in 2022. The US debate continues to rage over whether high prices are “transient” or “persistent”. Labels may not be useful – even if they are “transient,” how long will high prices last and where will inflation take place? Outliers – such as used car prices – are on the decline, but the US questions are still about “sticky” prices, such as housing costs.
That said, the 5 and 10 year breakeven points remain solidly around 2.5%. The Federal Reserve Bank of Atlanta’s “sticky” price index for August is currently around 2.5%, while the core is closer to 2%. The Dallas Fed’s 12-month adjusted personal consumption average is 2%. Moreover, the Fed has been crystal clear: if inflation is well above 2% and long-term expectations are not anchored around 2%, it will act. And frankly, if inflation were to settle at 3%, it could be good for the monetary authorities and not be as bad as the inflation of the 1970s.
Meanwhile, Japanese deflation remains entrenched. In the Eurozone, where everyone is talking about inflation temporarily hitting a whopping 3% year-on-year, the European Central Bank sees prices just above 2% this year and falling into the range of 1, 5% to 1.75% over the next two years. after exceeding its target for a decade. Annual inflation in China is less than 1%.
The American misery index in the 1970s was often around 15%, more or less, with inflation significantly higher than it is today. Today it stands at around 10% and almost all estimates predict that it will go down. The medium-term outlook in the United States, according to the Congressional Budget Office, is a return of unemployment to 4% and PCE inflation around 2% (consumer price index a little higher); by combining the two, we obtain a potential misery index of between 6 and 7%.
Figure 1. Average US consumer price index combined with unemployment rate,%
Roubini and others may be correct that supply chain disruptions will increase inflation, and for longer than expected. But the analogies with “stagflation”, evoking images from the 1970s, hardly seem appropriate. My bet is on stagnation, not stagflation.
Mark Sobel is the US President of OMFIF.