As inflation numbers tick up to levels that seem to belong to another era, the restlessness in some corners of markets and economics is verging on mutiny. You can almost hear the mumbles of “they’re mad!” about government leaders keeping their foot on the accelerator.
But those leaders are right to be undaunted. The very reasons for inflation picking up now are also why we should expect disinflationary pressures to come to the fore.
The most central explanation of current price pressures is that the pandemic has caused chokeholds in global supply chains. The notion of a “bottleneck economy” nicely captures how markets for products and labour are currently gummed up.
In the goods markets, lockdowns across the world have thrown supply chains out of whack. Empty containers sit in the wrong places (not helped by the recent blocking of the Suez Canal) and spending patterns have changed while people were stuck at home. As a result, shipping rates have soared, and prices are accelerating for raw materials and manufacturing inputs such as lumber and semiconductors.
In the labour market, the latest disappointing US jobs figures show that even with high vacancy levels, there can be obstacles in the way of hiring. If the job openings are not where the workers are, or require other skills than what the unemployed can offer, wage pressures can intensify even if employment rates are stuck below pre-pandemic levels.
But if the economy’s supply side suffers from bottlenecks, an apposite analogy is the glass ketchup bottle. You can shake and tap all you want, with no result — until suddenly it all comes flooding out and your food is smothered in ketchup.
The same will happen in supply chains that are currently blocked. Containers will eventually be moved to where they are needed. New ships will enter service if rates remain high. From forests to semiconductor foundries, there will be production increases. And as wages rise, more workers will move or train to take new jobs.
This is nothing new. Freight rates and commodity prices are always highly cyclical: it is not uncommon for global shipping costs to double or triple within a year and fall by similar amounts within the next. History indicates that supply responses overcompensate, ketchup bottle-like. Today’s shortfalls will produce tomorrow’s gluts, so the prices rising fastest today will face the strongest disinflationary pressures next year.
The other main reason people worry about inflation is that, in the US at least, stimulus programmes to boost demand are more expansive than anything the world has seen before. Even in Europe, governments have opted for unprecedented deficit spending.
The standard argument is that if the stimulus is too big, the result will be overheating. But even if this is true, it is not the whole truth. The exceptional fiscal support is just that. It will be withdrawn as the pandemic finally abates. We are about to observe the mother of all fiscal tightenings.
If you argue that the current fiscal stimulus is inflationary even if it is offset by a continued private demand shortfall, you cannot deny that its withdrawal is disinflationary by itself despite being compensated by a hoped-for explosion of private spending.
The relative timing matters, but the downside risk is much more serious than the upside potential. If the hump in public spending coincides with the rebound in private demand, a short spell of bottleneck economics will apply until budgets return to normal. If, however, consumers and businesses remain cautious and savings rates stay elevated as government stimulus is phased out, demand will falter just as supply capacity picks up. The result will be disinflation and protracted underemployment — politically toxic after the shock of the lockdowns.
To all this, we should add another, more speculative, consideration. It is well known that aggregate productivity tends to be procyclical — the private sector finds ways to squeeze more out of existing resources when demand is strong. In addition, the last decade proved that high demand brings people into work who were previously inactive. These findings suggest a possibility informing both Treasury secretary Janet Yellen and Federal Reserve chair Jay Powell. If demand pressure itself creates new supply capacity, it is wrong to take the foot off the accelerator pre-emptively.
Theoretically, expectations of rising inflation could be self-fulfilling. But in the face of imminent ketchup-bottle supply and unprecedented fiscal tightening, it is odd to think such expectations are likely to take hold.
Letter in response to this column:
Four lines that capture the ‘ketchup’ supply chain / From Peter Rose, New York, NY, US