Business

Inflation forecasts were wrong last year. Should we believe them now?


this time last year, economists were hopeful that the snarl in global shipping and manufacturing will soon disappear; consumer spending will shift away from goods and back to services; and the combination will allow supply and demand to return to balance, slowing the rise in prices of everything from cars to sofas. This happened, but gradually. It also took longer lead to lower consumer prices than some economists expected.

But the expected change is finally, albeit belatedly, appearing. After months of rebuilding the supply chain, consumers are already starting to feel the benefit. Used car prices have started decreasing meaningfully in October inflation data, furniture prices fall and clothing becomes cheaper. Such spending declines are expected to weigh on inflation next year.

“It is too early to declare that commodity inflation is over, but if current trends continue, commodity prices should begin to exert downward pressure on headline inflation in the coming months,” said Fed Chairman Jerome H. Powell during a recent speech.

Unfortunately, commodity price moderation alone is unlikely to return America to a normal rate of inflation as service price increases accelerate. That category — which covers everything from dining out to a month’s rent — accounted for half of consumer price inflation in October, based on a Bloomberg breakdown, up from less than a third a year earlier.

Many types of service inflation are closely intertwined with what happens in the labor market. For companies including hair salons, restaurant chains and tax accountants, paying employees is usually a major, if not the biggest, cost of doing business. When workers are scarce and wages are rising quickly, businesses are more likely to raise prices to try to cover larger labor bills.

This means that today very low unemployment and unusually rapid growth in wages could help keep prices rising faster than usual, even though the labor market wasn’t a big driver of the initial burst of inflation.

This is where Fed policy can step in. Companies can only charge more if their customers are able – and willing – to pay more. The Federal Reserve can stop this chain reaction by raising interest rates to slow demand.


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