Economists expect this year to be characterized by faster growth, shrinking inflation and healthy job creation — a far cry from the widespread fears of a recession that marked 2023. The National Association for Business Economics (NABE) on Monday predicted that gross domestic product — a measure of the value of goods and services — will rise 2.2% in 2024, a significantly more bullish forecast than what the group projected only two months ago.
Inflation, which drives up the cost of groceries, rent and car insurance, among other spending categories, is expected to continue slowing this year. NABE forecasts that the Consumer Price Index — a basket of common goods and services — will decline to an annual rate of 2.4% this year, compared with 4.1% in 2023 and 8% in 2022. Another economist said that the U.S. economy is growing much faster than other developed economies in Europe and Asia. He points to the job market as a key source of strength in 2024.
Here I want to make an important point about core inflation. From the point of view of everyday Americans, core inflation is nonsense. Gas in the car, home heating and food on the table are large parts of the total spending of most Americans. When Americans provide for their families, they don’t pay “core,” they pay regular CPI. That’s all you need to know when it comes to public policy, citizens’ well-being and (for politicians) how people will vote, says James Rickards. For the record, 3.9% inflation (CPI Jan 2024) cuts the value of the dollar in half in 18 years. The report signaled to the Fed that inflation remains an issue, and that its ideal 2% target remains elusive.
Where do these inflation numbers leave us? Again, it appears that inflation well above the Fed’s 2% target will persist for some months.
Today, lower inflation does not mean price declines; it just means prices are going up but at a slower rate. The damage of price increases from 2021–2023 is embedded in current price levels and will not go away.
So now – Is inflation over? Actually, no. And it may be getting worse.
Market expectations of rapid disinflation and a soft landing remain, but January has given a few new risks to the optimistic estimates of disinflation with no impact on the economy.
The first risk comes from the commodity complex and freight costs. Market participants have all but ignored the spread of geopolitical risk and assumed the extraordinary and counterintuitive decline in commodity prices in 2023 as something permanent. However, January has shocked analysts with a dramatic increase in freight costs and a significant bounce in oil prices. Furthermore, the December inflation figures in the eurozone proved that the base effect was an uncomfortably large driver of the consumer price index annual decline in November. In fact, all the components published by Eurostat in the December advance came significantly above the European Central Bank target.
The second risk comes from the significant bounce in net liquidity and effective money supply both in the United States and the euro area. Thus, the following three months will be critical to understanding the real disinflation process and whether market estimates are too optimistic. Unless the money supply declines again, the path to reaching 2% inflation may be challenging. The FOMC minutes came as a surprise to many when, like the ECB, members maintained their commitment to wait and see more than implementing immediate rate cuts.
We have been discussing too much about rate cuts and too little about net liquidity, sometimes forgetting that rising net liquidity has driven markets higher in the fourth quarter, and the first quarter will likely be more challenging considering the estimated volatility in the reverse repo figures. Additionally, massive deficit spending by the U.S. government may keep inflationary pressures above the level that broad and base money reductions would suggest.
The third risk comes from the inflationary impact of government protectionism. As trade barriers continue to build, the monetary disinflation process may be decelerating due to governments implementing trade wars, barriers to commerce, and tariffs. Unfortunately, governments in the euro area and the United States are tightening protectionist measures disguised sometimes as “environmental policies,” making competition more challenging and prices of food and shelter more expensive, by slashing access to land and farming as well as limiting building projects. Interventionism and trade wars make goods and services more expensive for citizens by placing a floor on prices even when monetary aggregates decline.
Food, commodities, and real estate inflation are all monetary effects. More units of newly created currency are going to relatively scarce assets. At the same time, deficit spending and the rising weight of government in the economy reduce the positive effects of monetary contraction and certainly decelerate the disinflation process. However, all those negative effects combined also contribute to the risk of a hard landing, especially when the U.S. and Europe are already in a private sector recession.
We need to be careful with excessive optimism about inflation and even more aware of the perils of expecting disinflation with no economic harm. Many market participants are suddenly surprised that January has started with a negative trend, but this is explained by the excessive expectations of aggressive and immediate rate cuts. – Daniel Lacalle
David Brady, Jr. – The Consumer Price Index numbers have recently come in with a slight decline to 3.1 percent YOY in January 2023. This is down from a peak in June 2022 of 9.06 percent inflation. Federal Reserve officials laude this as a victory. “Inflation has been conquered! Long live rate cuts!” they cry. The possibility of rate cuts has been touted after the fastest rate hikes in 40 years. Consumers, however, are not buying this rhetoric. The University of Michigan’s Consumer Sentiment Index saw an uptick, but nowhere close to its pre-COVID levels. Prices haven’t gone down for the average consumer even as inflation numbers “get better.” Why?
Source: Barron’s
It is important in any discussion of inflation measures to distinguish between the Core CPI measure that the Federal Reserve uses as a measure, and the “Headline” CPI. Both are an index measuring the general price level of a basket of goods. If one was to check the Consumer Price Index proper, they would find the index level at 309.685. That number may not mean much to the average consumer who glances at the data, but it becomes more readable when one calculates the YOY (year over year) percentage change.
Core CPI is different from Headline CPI in that the former removes so-called volatile goods like energy and food. The logic behind this exclusion is that energy and food prices are volatile. Their prices can change rapidly often as a response to political actions, disasters, and other supply shocks that will eventually be dealt with. These might not contribute to the overall increase in the price level in the long term, as the prices very well might lower or rise if they rapidly sink, so they are removed.
Core CPI is currently higher at 3.875 percent, meaning that when you include the volatile factors their prices have decreased. Looking to the Consumer Price Index’s Gasoline Index, you can find a decline from its peak in June 2022 (at 411.984) to today (at 293.287). Average gasoline prices have declined from a peak also in June 2022 at $5.05 on average to $3.21.
Food similarly has declined in terms of percentage change, but its price level continues to rise overall, even if it has slowed down. It appears that a decline in energy costs has pushed headline CPI down.
That aside, the CPI and Core CPI are down since 2022. Yet, consumer sentiment hasn’t recovered. Getting nearer to the coveted 2 percent inflation range hasn’t made things easier for most consumers. The inflation rate has continued to decline, but prices haven’t gone down overall, exempting energy prices. To properly understand this, one must understand how CPI and inflation rates work.
The Consumer Price Index is a measure of the general price level of a basket of goods over time. That basket changes as spending habits change over time. A base level for the index is at 100, and the standard inflation rate reported is a report of the percentage change over a year. The 3.1 percent inflation for January 2024 tells us that between January 2023 and January 2024 there was an increase in the index of 3.1 percent. A positive inflation rate means that the Consumer Price Index is still growing. As it becomes lower, that simply means it grows slower than previously.
The CPI continues to grow, meaning that the general price level has continued to grow. The inflation rate falling doesn’t necessarily mean that prices will return to their pre-COVID levels. Prices haven’t come down precisely because the price level continues to grow. To properly see a proper decline in the general price level, there must be deflation. Deflation would be reflected in negative inflation rate measures, as the CPI declines. To see a return to the pre-COVID price level there would need to be deflation enough for a decrease of 50 points on the index.
Austrians have long pointed to the connection between inflation and the growth of the money supply. The principle is simple enough when one understands marginalism. As the supply of goods increases, the value of an individual unit of those goods declines. To see a proper decline in prices to pre-COVID levels there is a need to see a decline in the money supply, all else held equal. Ryan McMaken has tracked the growing decline in the money supply as the Federal Reserve has raised rates, but the decline is not enough.
Source: Ryan McMaken at Mises.
The Federal Reserve may have slowed the growth of the general price level, but it has not done enough. There is a need for serious deflation if consumers wish to see prices return to where they once were. The price level is still growing, and it is easy enough to see if you understand what the inflation rate actually means.
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