The first in this two-part series on data journalism looked at various aspects of inflation in advanced economies and highlighted the differences between inflation in the United States and in eurozone economies. This part will look at the political economy around inflation in this region. Whether or not aggressively raising interest rates will control inflation has become a major topic of debate in advanced economies and it is not a debate limited to economists alone at the moment. Here are three charts that explain the main factors shaping this debate.
The Curious Case of Falling Consumer Sentiment But Rising U.S. Consumer Spending
In a sharp downgrade from its April forecast of 3.7%, the IMF now expects the U.S. economy to grow 2.9% in 2022. One of the main reasons for this downward revision was the expectation that the US Federal Reserve will raise interest rates in the future. . While the IMF expects the United States to “narrowly avoid a recession,” many private sector forecasts see a recession as a certainty. U.S. consumer confidence data, which hit a 16-month low in June as inflation concerns left “consumers anticipating that the economy will slow significantly or even fall into recession in the second half of the year”, points out such a predictions.
What is surprising, however, is the fact that US labor markets do not yet seem to be showing signs of distress. Data from the Bureau of Labor Statistics (BLS) shows that the monthly unemployment rate was 3.6% in May, remaining constant for the third consecutive time. The average hourly wage in the private sector rose 5.24% in May from a year ago and is 14.7% above pre-pandemic levels. While earnings growth in May is 23 basis points – one basis point equals one hundredth of a percentage point – lower than in April, it is still well above the average annual growth of 3.3%. in 2019.
But inflation seems to be eating into the political capital of governments in advanced economies
Despite robust macroeconomic indicators on unemployment and wages, governments in advanced economies have to fight inflation. Joe Biden’s government is calling for a three-month tax holiday on petroleum products, the UK government is facing labor strikes in various sectors demanding higher wages and in France, President Emmanuel Macron has lost control of the National Assembly during the June 19 legislative elections.
“Inflation has become a major policy challenge for President Biden and congressional Democrats. Only 31% of Americans said they approve of Mr. Biden’s approach to inflation; support has been muted even among Democrats, only 58% of whom said they approved of Mr. Biden’s approach, and only 15% of them strongly,” A New York Times report said . The growing impatience with inflation is the most important factor that could influence the political mood on inflation despite many credible economists, such as Joseph Stieglitz, arguing that raising interest rates is not going to help correct inflation right now.
And central banks may be overzealous in tackling inflation after having to eat a humble pie
Since most advanced economies adhere to the inflation targeting framework, inflation management is a responsibility of the monetary policy arm and therefore central banks. On this front, the central banks of most advanced economies, including the US Federal Reserve, did not see the inflation problem getting so bad.
In fact, nearly a year ago, Federal Reserve Chairman Jerome Powell said, “The Fed will remain cautious in any eventual decision to raise interest rates as it tries to feed the economy to full employment,” adding that he wanted to “avoid chasing” “inflation and potentially discourage job growth in the process,” said a Reuters story August 28.
Powell had to go from complacency to near helplessness. “The events of the past few months have increased the degree of difficulty. There is a much greater chance now that this (inflation) depends on factors beyond our control. Fluctuations and spikes in commodity prices could end up taking that option away from us,” he said in a statement. Wall Street Journal article June 15.
The only question is how far will central banks in advanced economies go on the path of rapid monetary tightening to restore their credibility at present. The U.S. Federal Reserve carried out the largest interest rate hike of 75 basis points since 1994, lifting the benchmark federal funds rate to a range of 1.5% to 1.75% in its last June 15 meeting. The European Central Bank confirmed its intention to deliver the first interest rate hike since 2011 of 25 basis points, from -0.5%, next month, Reuters reported on June 9.
While aggressive monetary tightening could restore the credibility of central banks in financial circles, it does not have popular approval. “Poll respondents were also critical of the approach taken by the Federal Reserve, which began aggressively raising interest rates in an effort to reduce inflation. Only 30% of Americans said they approved of the Fed’s handling of the issue,” said the previously cited New York Times report.
This is the second in a two-part series on inflation in advanced economies. The first part dealt with stylized facts about inflation.
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