Patience on Inflation Is Paying Off. Sort of.
Goods prices are falling and input costs have mostly stopped rising. Wage gains associated with labor market churn have slowed, although not enough, while restaurant price growth has accelerated.
Almost exactly a year ago, I wrote “The Case for Patience on Inflation”. My view was that the price spikes Americans had experienced were mostly attributable to the interplay of large one-time disruptions to our ability to produce with sharp changes in the mix of goods and services we wanted to buy. Eventually, those disruptions would end and inflation would normalize along with other economic conditions. The danger was that businesses and consumers would alter their behaviors to protect themselves from the risk of inflation in ways that would ultimately make everyone worse off—but surveys and spending data at the time both suggested that this was not happening.
Where do we stand today?
Troubles associated with the production and distribution of physical goods have been fading rapidly at the same time that demand has normalized. End prices for consumers have not yet fallen that much, which suggests that there could be room for further disinflation ahead.
Some job market indicators have moved much closer to pre-pandemic readings. Wage growth has slowed, although not yet by enough to be consistent with ~2% yearly inflation. Somewhat worryingly, the pace of the deceleration in wage growth (third derivative) seems to be moving in the wrong direction.
While the overall pattern of consumer price increases in October looked broadly encouraging at first glance, I am concerned by the remarkable persistence of inflation in sit-down restaurant prices. This is consistent with what is happening with the inflation measures that are taken most seriously by Federal Reserve officials.
I want to be optimistic that nominal spending growth can slow down enough to bring inflation back in line without decelerating so sharply that businesses decide to slash their capital budgets and lay off workers. But that benign scenario will require more than the continued normalization of the manufacturing and transportation sectors. As I explained last month, the pace of wage gains is key. While the data on this front are improving, the pace of improvement is what concerns me now.
Good News on Goods
U.S. businesses report that the cost of physical inputs continues to fall. That is a huge change compared to last year, when prices of materials, supplies, parts and components were jumping 1-2% each month.
At the same time, transportation costs are also normalizing. The Federal Reserve Bank of New York’s Global Supply Chain Pressure Index has plunged from a peak of about 4 standard deviations above normal at the end of 2021 to just 1 standard deviation above normal in September and October 2022.