The U.S. economy can’t be this weird forever. That’s what I keep telling myself, anyway. Eventually, I think, financial news will be boring again. Eventually, I pray, the U.S. economy won’t resemble some ever-morphing Rorschach blot. But after a year of shortages, a Great Resignation, and rising inflation, I’m still waiting for normalcy.
Here are three questions that get to the heart of what makes this moment so strange. Answering them, or at least attempting to answer them, could help indicate where things go in the second half of the year.
1. If gas prices are plummeting, why is inflation rising?
In the past two weeks, we’ve seen all sorts of evidence of “disinflation”—a decline in the rate of inflation. Retailers including Target, Gap, and Bed Bath & Beyond say they’re swimming in merchandise that they’ll have to discount. Oil prices have plunged, and gasoline prices are now coming down fast. The cost of shipping goods from China is falling. Microchip inventory is rising, which should bring down the cost of electronics. The prices of commodities such as natural gas, wheat, lumber, and other raw materials are plummeting.
Falling prices sounds like we’ve reached peak inflation. But on Wednesday, the Bureau of Labor Statistics reported that annualized inflation had surged to 9.1 percent. That’s the largest increase since November 1981. This seems utterly confounding. Inflation is a measure of the growth in prices. If prices are going down, how can inflation be going up?
The optimistic possibility is that the great disinflation has only just begun, and it wasn’t captured by the most recent report. The government’s latest data cover the month of June. But all those suddenly falling prices—on goods, energy, chips, and materials—are stories from the very end of June and early July. Plausibly, inflation was surging for much of early June and then peaked just as the calendar flipped. That means we should expect next month’s report to be much better.
But as the writer Noah Smith argues, something stranger and more disturbing may be happening. Perhaps inflation keeps contradicting optimistic headlines because the Federal Reserve has lost its magic touch.
That’s conceivably what happened in the 1970s. The oil shock came and went, but inflation kept raging as the Federal Reserve’s interest-rate hikes and forecasts did little to stabilize prices. Ultimately Fed Chair Paul Volcker jacked up interest rates to 19.1 percent in the early 1980s to demonstrate how serious he was about crushing inflation. (By contrast, today’s federal-funds rate is still below 2 percent.)
For the last year, the dynamic between the Fed and the economy has been a bit like a classic scenario of a parent driving a car while noise inflation steadily rises from the backseat. “Knock it off, please,” the parent says. But the noise rises. “I said: Knock it off!” the parent repeats. And the kids just get louder. This is what it’s like for the Fed to lose credibility; small interest-rate hikes are met with accelerating price growth. The only way to beat this sort of inflation is for the person in the driver seat to do something dramatic to prove that the status quo is intolerable. If the Fed raises interest rates by a full percentage point in its next meeting, that will be a lot stronger than requesting a moment’s silence from the back seat. That’ll be more like doing a sharp U-turn, and speeding in the opposite direction until the kids promise not to speak louder than a whisper for another 35 years.
I really, really hope that our Great Disinflation moment is right around the corner. I don’t want the Fed taking a hard left and yanking up interest rates to crush the economy. But we can’t rule it out yet.
2. If jobs are growing, why is the economy shrinking? And if prices are rising, why are wages falling?
If the only economic statistic you followed was the monthly jobs report, you’d assume that the U.S. is booming. Two years ago in June, the unemployment rate was 11 percent—the highest since World War II. Today, it’s 3.6 percent—just 0.1 points away from being tied for the lowest unemployment rate since World War II. That’s a remarkable turnaround.
But if the only economic statistic you followed was GDP—and the Atlanta Fed’s unofficial GDPNow forecast—you might assume that the U.S. is in a recession. The economy contracted last quarter, and the Atlanta Fed now estimates that with the pullback in manufacturing, construction, and exports, GDP is still contracting by about 1 percentage point, annualized. Two consecutive quarters of negative growth is typically (but not always) a sign of a recession.
No economy this crummy has been so amazing for finding work; but also, no economy this good for finding work has ever been this crummy. The gap between GDP and employment is the highest on record—a smashing violation of Okun’s law, the rule that employment and growth tend to move up or down in lockstep.
I’m sorry if this mystery already seems impossibly convoluted, but there’s more. Rising inflation typically occurs alongside rising wage growth. But that’s not happening right now. Weekly earnings growth has been falling; adjusted for inflation, average weekly earnings have turned sharply negative.
In sum, jobs are up, but growth is down; and inflation is soaring, but wage growth is falling. Huh?
One explanation is that rising material costs—such as energy, lumber, and metals—have dramatically held back growth, even as jobs are plentiful. That might also explain why average hourly earnings are decelerating, while inflation is accelerating: Materials costs have gobbled up the rest.
A second possibility is that companies are responding chaotically to rapid changes in demand, which is creating a “bullwhip effect.” Bloomberg’s Joe Weisenthal described it this way:
Goods become scarce. Companies fear that they will be unable to have goods to sell. They start to over-order key components, just to be sure they can keep operating. This makes goods more scarce. Eventually the cycle turns. Everyone has ordered too much. Orders get slashed. Gluts emerge. Prices fall. You know the drill.
Many companies might be at a moment in the bullwhip cycle where inventory has piled up. So they’ve slashed their orders, without yet laying people off. If enough firms did this at the same time, you’d see output declining in an economy with low unemployment. And that’s exactly what we’ve got.
A third possibility is that productivity has declined in the past few months, perhaps because of some combination of COVID, work-from-home ennui, and the aftershocks of the Great Resignation. Here’s one scenario: Let’s say you own a restaurant. Every month during the Great Resignation, one-seventh of your workers quit. Now you’ve got almost all-new kitchen staff and waitstaff, and you can’t train them fast enough. The new chefs keep messing up your nightly specials. The new waiters keep dropping plates. Every week, somebody seems to get COVID. Yes, your restaurant is fully staffed. But are you working at full capacity? Not a chance!
The chief executive of Delta recently described his airline like a real-world version of this hypothetical restaurant. “Since the start of 2021, we’ve hired 18,000 employees,” he said. “A chief issue we’re working through is not hiring but a training and experience bubble, coupling this with the lingering effects of COVID.” If many companies are stuck in this chaos bubble, it would make sense that employment is strong but output is a bit of a mess. A lot of new workers just don’t really know what they’re doing right now, and companies don’t have the capacity to train them.
Finally, the economic data might just be wrong, or temporarily janky. I’m not a Shadowstats guy. I don’t think the BLS is lying, and I trust that government analysts are doing the best they can. But monthly statistics are subject to sharp revisions. Maybe we are in a moment of transition, where the data are simply not going to make sense for a bit.
3. If consumers are miserable, why is leisure spending on fire?
Americans seem to be having a grand old time. Leisure travel is so strong that airports can barely keep up. The movie-theater box office has already set several holiday-weekend records. Despite lingering COVID fears, hotel occupancy this summer is matching its 20-year average, and restaurants are packed.
But if you ask Americans how they’re feeling about the economy, you’d better bring a pack of tissues. Consumer sentiment has plunged to its lowest rate on record.
I’ve previously suggested that Americans have an everything is terrible, but I’m fine mentality about the economy. Asked about the state of the country, we’re lugubrious. “Things have never been worse,” we tell pollsters over and over. Asked about our own lives or finances, our mood lightens significantly.
But maybe I should give the American public a bit more credit. With plunging stock values and medium-term Treasuries, the market seems to be betting on a recession or something like it. Perhaps Americans are internalizing that message. Perhaps they intuitively sense that a recession is near, so they’re getting in their last thrills before the economy tips over.
Months from now, we may look back on the summer of 2022 and realize that this apparent weirdness was pretty self-explanatory, after all. We might look back and say:
America’s labor recovery was impressively swift because it coincided with an unsustainable boom in demand. Along with supply-chain challenges, this creation a classic surge in domestic inflation, with too much money chasing finite goods and services. The Federal Reserve responded by turning up interest rates to crush demand. And this predictably caused a downturn in spending and investment. In the handoff from boomflation to recession, gas prices fell before inflation, growth fell before employment, and sentiment plunged before spending. In the end, it all went in the same direction: down.
What I’m describing here is a recession. And I don’t like how plausible the story sounds. If this is the most likely alternative to the everything-is-weird economy, then I say: Keep the American economy weird.
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