There’s growing confidence among central bankers that inflation can be controlled without causing a significant spike in unemployment, as economists predict a “pristine disinflation”. Economists from Consensus Economics predict a drop in inflation from the high levels of recent decades to around 2 per cent this year in top economies such as the UK, US, Germany, France, Italy, and the euro zone.
Historically, the battle against inflation often results in a steep price, pushing economies into recession and causing unemployment levels to soar as rigorous financial policies are implemented. In the 1980s, for instance, the unemployment rates in the UK and US doubled due to increased borrowing costs brought on by tackling rampant inflation caused by oil price shocks.
However, views are altering about this inflationary cycle. Michael Saunders, an economist at Oxford Economics, expects inflation to reach its target with only a slight rise in unemployment in the US and euro zone, a scenario he describes as “pristine disinflation”.
Over the past two years, inflation has already been reduced by over 50 per cent across the Atlantic. In February, euro zone price growth was at 2.6 per cent, a significant decrease from the record high of 10.6 per cent in 2022. In the UK, inflation dropped from a high of 11.1 per cent to 4 per cent, and from 9.1 per cent to 3.2 per cent in the US.
Unemployment is currently at an all-time low in the euro zone and is predicted to average 4 per cent this year in the US, quite close to the 50-year record low of 3.6 per cent in 2023, according to the most recent survey by Consensus Economics. The unemployment rate in the UK is anticipated to only slightly increase to 4.4 per cent in 2024 and further to 4.5 per cent in 2025 from a nearly 52-year low of 3.9 per cent.
This scenario, termed as “disinflation at full employment”, is a distinctive occurrence in the modern economic history, as highlighted by Andrew Bailey, governor of the Bank of England, last week. He noted that the UK is not the only one experiencing this phenomena of disinflation while maintaining full employment.
Adriana Kugler, belonging to the Federal Reserve Board, remarked earlier this month that despite the rapid escalation of interest rates, the incessant rise of unemployment due to the costs of disinflation was a concern. However, it was observed that inflation has significantly reduced at a rate higher than ever since the 1980s in the last year or more, even though the unemployment rate remains almost stagnant at its lowest since the 1960s.
A number of economists such as Mr. Bailey and Ms. Kugler have associated this occurrence to the nature of recent inflation outbursts, which were primarily linked to international supply disturbances like the full-fledged invasion of Ukraine by Russia and issues associated with the pandemic.
Mr. Saunders commented, “The inflation increase in advanced economies between 2021 and 2023 is unique as it largely signifies detrimental supply shocks rather than enhanced aggregate demand.”
Jennifer McKeown, the Principal Global Economist at Capital Economics, mentioned that high wage growth, closely supervised by policymakers as a potential provocateur of domestic price flux, emerged from the increase in inflation expectancy associated with a spike in energy costs and pandemic-initiated labour scarcity in certain sectors.
She claimed that such a wage increase was beginning to recede, even without a significant increase in unemployment, as the inflation expectation and price growth found a balance as discrepancies due to Covid-19 levelled off.
The success of this is also accredited partially to the promptness of the central banks’ intervention in ensuring higher inflation did not become more tenacious, as economists stated.
“The ‘70s-‘80s supply shocks got rooted because the central banks were unable to comprehend the significance of inflation expectancy present in numerous labour contracts and its effect on the cost of living adjustments,” remarked Mark Zandi, Chief Economist at Moody’s Analytics.
He supplemented by saying that the trend seemingly instigated by impeccable disinflation was, in fact, decipherable, despite it appearing indecipherable. He claimed that “disinflation is predominantly an aftermath of the receding economic consequences of the pandemic and the war waged by Russia in Ukraine”. He asserted that this was, indeed, foreseeable.
With the effects of these shocks dissipating rapidly, the delivery times have reverted back to its pre-pandemic state and shipping expenses are merely a fragment of what they were back in 2021. It was noted that the prices of wholesale gas in Europe and global agricultural commodities have essentially returned to their state in early 2021, prior to their escalation due to the war.
A decrease in inflation, earlier than projected by central banks last year, is being supported by various elements. These aspects are further contributing to a downward shift in inflation outlooks, minimising the likelihood of persistent price pressures influencing wage discussions. “I’m gently hopeful that we’ll witness ongoing improvements in disinflation without a notable downturn in the employment market,” stated Ms. Kugler. – Copyright Financial Times Ltd 2024.