The minutes of the Fed's regular December 2021 monetary policy meeting, released in early January, show that in view of the changing situation, the Fed decided to double the size of the monthly asset purchase reduction that began in November, and also considered raising interest rates early and subsequently starting to reduce the balance sheet faster. The Fed's future benchmark interest rate dot plot shows that most GM members expect three rate hikes in 2022, and Fed Chairman Powell further hinted at a more aggressive response during a congressional hearing on January 11. Recently, Goldman Sachs Group and other institutions expect the Federal Reserve to raise interest rates four times in 2022.
Most Fed officials predicted no rate hikes before 2024 more than half a year ago, and most of the fed officials at its regular meeting in November expected no rate hikes in 2022, but given the rapid evolution of the economy, the Fed had to change course to avoid "lagging too far behind the inflation curve." Powell has been in charge of the Federal Reserve for less than four years, monetary policy has undergone four larger than expected adjustments, the market jokingly called "the Powell pivots" earlier specifically referred to the 2018-2020 market policy, and recently added "dove eagle conversion" and stepped up withdrawal of new content.
Professor Lu Feng of the Jinguang Chair of the Peking University Development Institute
Although the Fed's policy dynamics are related to the relatively rapid recovery of the US economy, it is also a passive response to the real dilemma of soaring inflation. With the promotion of vaccination and the increase in adaptability to the epidemic, the US economy will recover relatively quickly in 2021: positive growth resumed in the first quarter, GDP growth rebounded to a high of 12.2% in the second quarter with the help of the base effect, and after the growth rate fell back to 4.9% in the third quarter, it is expected to rebound to 6.7% in the fourth quarter, and the annual growth rate is expected to be about 5.6%. The economic rebound led to an improvement in the labor market, and the unemployment rate fell rapidly from a peak of 14.4% in April 2020 to 3.7% in December 2021. The improvement of the macroeconomic situation provides favorable conditions for the Fed's policy adjustment.
The Fed's early start and acceleration of its exit from the ultra-wide stimulus policy are the product of rising inflationary pressures beyond expectations. The chart on the left below shows the monthly data for consumer price growth in 2021, which grew from 1.4% at the beginning of the year to about 5% in the middle of the year, which has significantly exceeded the Fed's target; inflation levels continued to rise in the fourth quarter, rising to 6.8% in November after breaking 6 in October, and the latest data rose to 7% in December, the highest monthly growth rate in 40 years since the early 1980s (right). In the face of the facts, the Fed has to admit that the sustainability of inflation exceeds its earlier predictions and model forecasts, and then abandon the "inflation temporary theory" stance, start ahead of schedule and accelerate the adjustment of ultra-wide monetary policy since the 2020 epidemic.
Although the Recent Haste of the Fed is in the category of short-term macroeconomic policy, it is also valuable for observing and understanding the evolution of the US economy and policy. In the 21st century, especially after the financial crisis, the US macro policy has continued to change in the direction of radical easing along with the changes in its internal and external economic environment: monetary policy is loose and then relaxed, fiscal policy changes the earlier cycle balance policy to stimulate maximization, and the academic circles also have modern monetary theories to echo and bless, giving people a dizzying sense of dazzle. The overall image gives the impression that the privileged status of the superpower seems to give the United States boundless mana in the endless implementation of macroeconomic stimulus policies, and the objective role of macroeconomic laws seems to no longer exist.
The significance of the new round of inflation in the United States is that the US macro-stimulus policy has continuously stimulated and increased the reins for a period of time, which is essentially a phased phenomenon, and it is not really able to transcend the constraints of theory and reality. As a major issuer of international currency status, the United States' monetary stimulus and debt expansion space is comparable to that of ordinary countries, but there is still a deep check and balance mechanism behind the seemingly unlimited expansion. Real inflation is a yellow card warning that the Fed has to face when it blindly expands its policy, a key fulcrum for macroeconomic laws to play an objective role, and an Achilles heel of the US economic policy system. This important phenomenon needs to be observed and discussed from different perspectives.
As Xi Zhe said, it is impossible for a person to step into the same river twice, and economic laws and abstract concepts are expressed through special forms. Observing the new inflation in the United States, we will see that this inflation has novel contents in terms of basic types, occurrence processes, internal structures, and root causes, and shows distinct alternative characteristics.
The alternative nature of new inflation in the United States can be observed in different ways.
First, inflation in the United States seems to have been sudden, largely exceeding earlier expectations. This unexpected characteristic is particularly prominent in the Fed's changes in thinking and views on inflation.
After the "Walker Moment" of the early 1980s, the U.S. economy ushered in decades of low inflation. Lower inflation volatility after entering the 21st century is interpreted as a potential deflationary risk. Under the influence of the new monetary school of thought at the turn of the century, in order to preemptively deal with the number one risk of deflation, the Fed's policy approach has evolved from an earlier focus on containing inflation to later striving to fight high inflation. After the three waves of quantitative easing after the financial crisis, the inflation stability policy has not been able to achieve the 2% target, and the Fed revised the monetary policy target framework in 2020 to introduce the so-called "flexible average inflation target (FAIT)", promising that if inflation is low for a period of time, the Fed will allow inflation to be above the target value in the corresponding period, in an attempt to raise public inflation expectations to beat high inflation.
In this context, when inflation first began in the first half of 2021, the Fed insisted that the price increase was mainly due to the fact that some of the supply capacity was not actually released due to the epidemic, and predicted that it would tend to disappear as the epidemic was controlled and the supply system returned to normal, so it maintained a super loose monetary policy of buying $120 billion of securities and zero interest rates per month. At the regular monetary policy meeting in September 2021, the Fed still stuck to the temporary view of inflation when analyzing the inflation situation, and had to abandon the relevant position until the fourth quarter, and decided at the regular monetary policy meeting in November to reduce the size of bond purchases and start the tapering. It can be seen that from the perspective of the emergence of inflation in the United States and the process of change in the understanding of policy departments, the super-expected inflation of this round reflects its alternative characteristics.
Second, compared with the five inflations that have occurred in the past half century, the current inflation is different from the characteristics of price increases. The table below shows that consumer prices in the United States grew by 7% year-on-year in December, higher than the monthly peaks of inflation in 1990 and 2008 (6.3% and 5.6%), and lower than the levels of inflation in 1974 and 1980 (12.3% and 14.8%), which is not very out of line. Some aspects of price movements are also similar to historical empirical patterns, such as energy prices rising significantly higher than overall prices during inflation, food price increases that are closer to overall inflation, and so on. The most important structural feature of this inflation is the abnormal relative increase in commodity prices.
The data in the table above shows that commodity prices grew by 10.7% year-on-year in December last year, 50% higher than the overall increase in the CPI by 7%. Compared with previous inflations, commodity price increases were lower than the general increase in the CPI: in 1974 and the next four inflations, commodity price increases were 1.6%, 39.2%, 46% and 89.3% lower than the CPI, respectively. The comparison with service prices also highlights the higher increase in commodity prices. Compared with the earlier inflations, except for the 1974 increase in commodity prices, which was 14.2% higher than the price of services, the prices of the other three commodities were 43.7%, 46.0% and 81.8% lower than the price increases of services, respectively. Last year, the price of individual services in the US service industry, such as hotel services, recorded a high year-on-year growth rate of 27.6% in December, but the overall growth rate of the service industry was 3.7% year-on-year, and the price of goods was nearly 2.9 times the increase in service prices.
The direct reason for the higher increase in U.S. commodity prices last year was that, in addition to a nearly 30 percent surge in energy prices, auto sales prices also rose sharply: new car prices rose 11.8 percent, and used car prices even soared to 37.3 percent. Mainly due to the sharp increase in the prices of gasoline, automobiles and their parts, the prices of "transportation" goods and services that are not reported in the above table have increased by more than 20% year-on-year. It is also worth noting that the rapid technological progress of computers and components and accessories, and the production process of goods deeply embedded in the global supply chain, the price of goods in the early period continued to decline, and recently there has been a significant positive price increase.
Third, the alternative feature of US inflation last year was that there was no longer a normal positive relationship between the soaring inflation and the yield on The Treasury bond. Under normal circumstances, when inflation pressure rises, the Federal Reserve will raise interest rates in time to respond, and even out of the pre-emptive strategy to consider early tightening of monetary policy, the Fed's benchmark policy rate is higher to drive the market interest rates, including Treasury yields, to rise, resulting in the positive relationship between inflation and yield shown in the monthly data since 1960 in the following figure (blue sample point). Inflation soared above expectations last year, the Fed was limited to the short-term analysis of inflation and subject to the technical constraints of the ultra-large-scale volume and wide policy, unwilling and inconvenient to use tightening measures such as interest rate hikes in time to deal with it, resulting in a temporary decoupling of inflation changes and yields, which is an atypical relationship between the red sample outliers in the following figure.
Finally, from the perspective of economic common sense and history, last year's US inflation was significantly different from the two types of inflation that economists are familiar with in terms of type comparison and mechanism of occurrence. Most of the common inflation in contemporary times is related to economic overheating, characterized by the overexpanding of aggregate demand under the condition that the total supply capacity is fully utilized, resulting in economic overheating imbalance and inflation, and economics recommends that the prescription for controlling such inflation is mainly to use various tightening policy tools to suppress aggregate demand. The other is inflation that accompanies economic slowdowns and even recessions, the so-called stagflation, which logically means that there is a special cost-driving mechanism relatively independent of aggregate demand and economic growth, and the US and European economies in the 1970s faced the impact of the oil crisis and superimposed excessive regulatory distortions, making this kind of inflation an empirical fact. The reality of stagflation is incompatible with the logic of Keynesian theory, which contributed to the paradigm shift in economic policy in the United States and Europe in the 1980s.
In terms of type comparison, new inflation in the United States is not the same as the above two types of inflation.
The first is that the recent link between inflation and the rebound in the US economy cannot naturally be said to be stagflation. Referring to last year's U.S. economic growth, the 5.6% forecast growth rate should be the highest annual growth rate in the United States since 1984, which obviously does not meet the requirements of stagflation in the deceleration recession and inflation combination. Of course, last year's high economic growth rate in the United States is largely a repair to the rare economic contraction caused by the epidemic in 2020, and the average economic growth rate during the two-year epidemic period is still lower than the potential economic growth rate of the United States, in other words, the US economy may not have reached the pre-epidemic trend level by the end of 2021, but in terms of the synchronic relationship between inflation and economic growth, new inflation is different from stagflation after all.
Second, there are substantial differences with typical demand-driven inflation. The key is that the release of supply capacity in response to the expansion of demand is inherently constrained. For example, from the perspective of the labor market situation, the main indicators of the employment situation have substantially repaired and improved with the economic rebound, but there is still a significant gap compared with the high point of the cycle on the eve of the epidemic, indicating that the full realization of the potential of labor supply in the severe inflation environment still faces obstacles. The U.S. unemployment rate fell to a low of 3.7 percent last December, though it is still far from the pre-pandemic low of 3.3 percent. Non-farm payrolls grew from 131.02 million in April 2020 to 153.48 million at the end of 2021, still about 2 percentage points below the November 2019 high of 156.58 million. The employment rate and labor force participation rate rebounded to 59.4% and 61.7% respectively in December last year, but there is still a gap compared with the 2019 highs of 61.2% and 63.6%.
From the perspective of industrial supply, the high point of inflation and the high point of capacity utilization in the earlier economic cycle roughly overlapped, such as the industrial capacity utilization rate of 89% and 86% at the high point of inflation in 1973 and 1979, respectively. U.S. inflation soared last year while industry still hasn't fully recovered, with industrial capacity utilization at 76.5 percent in December 2021, still significantly lower than the 79.9 percent before the pandemic in August 2018. The U.S. Industrial Production Index for December 2021 remained 2.2 percentage points lower than in August 2018. A similar situation exists in the manufacturing capacity utilization rate. These data show that the supply capacity of the US economy is limited in terms of its own recovery and matching demand, and there is a supply bottleneck that is generally rare in more mature economies like the United States, making the current inflation in the United States and the common economic overheating inflation also have important differences. To understand the mechanism and specific reasons for the formation of alternative characteristics of new inflation in the United States, it is necessary to analyze and discuss the superposition of the new crown epidemic epidemic and super stimulus policies.
Author: Lu Feng, Liu Jun, Ren Hui
Source of this article: NetEase Research Bureau