Why economists got it so wrong on US inflation

The government's latest inflation on Nov 10 showed a 6.2 per cent annual jump in consumer prices that exceeded all projections. PHOTO: AFP

NEW YORK (BLOOMBERG) - Economists are getting a dose of humility on forecasting inflation after a resurgent coronavirus, a tenuous global supply network and stimulus-fueled consumers combined to send United States prices well beyond the expectations of Wall Street and policy makers.

The government's latest inflation read on Wednesday (Nov 10) showed a 6.2 per cent annual jump in consumer prices that exceeded all projections. Previously confined to categories mostly associated with the economy's reopening, the October data indicated a broadening of inflationary pressures.

Forecasting inflation "has been incredibly challenging" over the past year and will remain tough, said Deutsche Bank chief US economist Matthew Luzzetti. "It is difficult to feel comfortable with a view that you are building in enough price pressures at the moment, and risks remain skewed to the upside for the inflation outlook."

Since the start of the year, economists have been forced to ratchet up their projections for consumer price growth. What was once expected to be a bit of mirage, with so-called base effects distorting the figure higher, has proved to be a much more persistent problem.

US Federal Reserve chair Jerome Powell and many of his colleagues have repeatedly said this year that inflation pressures will prove transitory.

Last week, Mr Powell said he will not entertain interest rate increases until the labour market heals further, even though inflation could run hot for months.

Some prominent economists, including former treasury secretary Larry Summers and former New York fed president Bill Dudley, have been warning about higher and more persistent inflation for nearly a year.

Goods Rotation

Many expected the vaccine roll-out to embolden Americans, whose savings grew from government financial support, to transition more of their disposable income to services. US President Joe Biden's US$1.9 trillion (S$2.57 trillion) American Rescue Plan, passed in March, included an extension of enhanced unemployment benefits and US$1,400 cheques for millions of consumers.

The thinking was that as more people travelled, dined out and attended entertainment venues, the less they would spend on merchandise. That would, in turn, help remove some of the strains on the supply chain.

But the Delta wave of the virus kept massive pent-up demand skewed towards merchandise and added further strain to supply chains, particularly in Asia, said Moody's Analytics head of monetary policy research Ryan Sweet.

Retail sales are well above pre-pandemic levels, while services spending has yet to catch up.

"A big theme that people anticipated over 2021 was this big rotation within consumer spending from goods to services, and while that has happened to an extent, goods spending has exceeded expectations," Mr Luzzetti said.

Continued strength in goods spending put added pressure on a fragile supply chain. Lean domestic inventories forced US producers and retailers to step up import orders. At the same time, other economies around the world were stirring from their pandemic-related lockdowns.

While Mr Sweet expected late last year that supply chain issues would be more problematic and persistent than many thought, he has been surprised by recent readings. "I didn't think the CPI (consumer price index) would get as high as it has recently," said Mr Sweet, who has consistently ranked high this year in Bloomberg's quarterly lists of top forecasters.

Complicating matters was Covid-19's impact on the job market. Heading into this year, many economists projected ongoing slack in the labour market would help ease inflationary concerns.

Instead, a depressed participation rate has pushed job openings to near-record levels and led to a record surge in wages. Large companies have raised prices to offset higher labour costs.

Squeezed Firms

"Businesses are being squeezed on both ends," said State Street Global Advisors senior economist Simona Mocuta. This is happening against a backdrop of "strong consumer liquidity, so pricing power is improving".

As at last month, the participation rate, which measures those employed or looking for work, has recovered less than half of its pandemic-related collapse. Many forecasters saw hiring constraints easing as schools reopened and supplemental unemployment benefits ended, but that has not been the case.

Higher energy prices are also contributing to faster inflation.

Consumer prices for energy are up 30 per cent from a year earlier, the largest annual advance since 2005. Petrol is up nearly 50 per cent. The price of electricity last month increased 6.5 per cent from the same month a year ago, the most since March 2009.

US prices for natural gas and oil are trading close to multi-year highs amid a global squeeze on supplies, while labour shortages at US coal mines create further price pressures. The Energy Information Administration expects this winter to be the costliest since at least 2014-2015.

Americans' inflation expectations - which tend to be closely tied to prices at the pump - have also drifted higher.

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