One year ago, the unemployment rate had fallen to near 4%, output was at record levels, but the inflation rate was blasting through 7%, causing the Federal Reserve to begin to slow its purchases of securities.
It was a shock for post Volcker generations without inflation remembrances. For most of us, Kherson and Zelensky were just names. The expectation was that 2022 would be slower than the stimulus fueled snap back in 2021, and inflation would moderate. That optimism was soon shattered.
The toxic confluence of excessive stimulus, drought, European energy shortfalls, a global rebound, and lingering pandemic disruptions that proved to be more than transitory gave us the inflation of 2021. On Feb. 24, 2022, Russia invaded Ukraine, sending further shocks into energy, food, and other commodity markets. The inflation rate rose further, hitting 9.1% in June and was a global issue.
The Fed began to increase its target rate in March––25 basis points followed by 50 and then three 75 basis point moves. This was 1979 all over as Powell and other Governors sounded like Paul Volcker, determined to bring down inflation. Mortgage rates doubled, financial markets plummeted, and the dollar soared. Gross Domestic Product fell slightly during the first half of the year, as inventory and trade gyrations outweighed rising consumption on services. Growth in Q3 rebounded on strength in trade. All the while, employment has continued to increase.
As 2022 winds down, central banks around the world have moved to dampen inflation––a global tightening. U.S. growth prospects for 2022 have headed towards 1% to 2%. The labor market, while strong, has shown declines in open positions to 10.1 million, and a 263,000 net gain in September jobs. The unemployment rate declined to 3.5% while annual inflation was 8.2%. There was scant evidence to suggest that inflationary pressure would soon diminish.
With the benefit of 20/20 hindsight, mistakes were made and have been admitted by policy makers. The price pressures from the pandemic were longer lasting than implied by the transitory label used in 2021. The labor market disruption and the drop in the participation rate led to an underestimation of the tightness in the job market. The massive stimulus in the spring of 2021, when the upturn was almost one year old, was excessive and added to inflationary pressures.
It is interesting that in August 2020, the Fed announced its Flexible Average Inflation Target––tolerating inflation above the 2% target after a period of below target inflation. For years they had been unable to achieve the 2% target: quickly the problem changed.
As one looks ahead to 2023, the anti-inflation policies of the Fed will continue with further rate increases this month and in December. The dampening effect on housing related activity is well underway and the wealth effect from falling net worth is in its initial stages. Supply shocks continue with recent OPEC action and covid lockdowns. The Fed is waiting for signs of diminishing price pressure, vowing not to let up too early, thereby forcing more serious action down the road. They are seeking to regain their hard-won credibility from decades ago.
The coming year is fraught with uncertainty and black swan potential. The monetary brakes are still being applied with their long and variable lags. The guns of February continue to rumble across what Timothy Snyder called the Bloodlands of Europe, ravaged by Stalin, Hitler and now Putin, with ominous threats and weaponized energy.
The risks are on the downside with a year of 1% or less growth likely. On the price side there are some signs of softening in commodity markets, supply chains are improving with falling shipping rates and better performance. The year ahead should see inflation move down towards the 3% to 4% percent range. Whether or not it will be a recession will depend on the aptly named Dating Committee of the NBER. The rampant pessimism should be tempered by the labor market where recent experience may make employers reluctant to reduce employment; by debt payment burdens of consumers, which are below pre-recession levels; and by housing which is not in freefall with liar loans and faulty underwriting a la 2007-2009.
The nation will emerge from the 2020-2022 period an altered place. Old business models are challenged by hybrid workplaces, AI, and internet advances. Squeezing out inventory to reduce costs is giving way to redundancy, alternative suppliers, supply chains, domestic production requirements, and incidentally higher costs. One can call it diminished globalization, friend shoring or protectionist rent seeking by influential groups.
The reality of a slower growing, aging labor force is no longer an academic projection. It is here and now. The role and size of government has increased with expanded entitlements, drug price controls, interventions, industrial policy in the CHIPS Act and the cleverly named Inflation Reduction Act. Stay Tuned!
Dr. John Mitchell, who currently is principal of M&H Economic Consultants, previously served as chief economist of U.S. Bancorp.
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