(What’s Left of) Our Economy: Why the Really Tight U.S. Job Market Isn’t Propping Up Much Inflation

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CCP Virus, consumer spending, consumers, coronavirus, cost of living, COVID 19, Federal Reserve, headline PCE, inflation, inflation-adjusted wages, interest rates, Jerome Powell, monetary policy, PCE, personal consumption expenditures index, prices, recession, stagflation, stimulus, wages, {What's Left of) Our Economy

It’s been widely assumed that even though very tight U.S. labor markets haven’t yet touched off the kind of wage-price spiral that can supercharge inflation, they’ve been helping consumers offset the effects of rapidly rising prices – and therefore helping to keep living costs worrisomely high.

The intertwined reasons? Because even though when adjusted for inflation, wages generally have been falling since price increases took off in early 2021, rock-bottom unemployment rates and the wage hikes that have been received have enabled healthy consumer spending – and given business unusual pricing power.

Most important, this is what the Federal Reserve believes, and it’s the federal government institution with the prime responsibility for fighting inflation. According to Chair Jerome Powell, “demand for workers far exceeds the supply of available workers, and nominal wages have been growing at a pace well above what would be consistent with 2 percent inflation over time.”

For good measure, Powell said that the labor market “holds the key to understanding inflation” especially in U.S. services industries other than housing, which make up more than half of the set of inflation data favored by the Fed, and where “wages make up the largest cost.”

How come, then, when you look at the wage data put out by the federal government, it’s so hard to find evidence that recent wage levels have significantly bolstered U.S. workers’ spending power during this current high inflation period?

Given the Fed’s power, it makes sense to use the inflation measure it values most – which as RealityChek regulars know is the Personal Consumption Expenditures (PCE) Price Index. As the Fed prefers, we’ll focus on the “headline” gauge, which includes the food and energy prices that are stripped out of a different (“core”) reading supposedly because they’re volatile for reasons having nothing to do with the economy’s underlying prone-ess to inflation.

And for the best measure of the wages workers are taking home, we’ll use weekly wages. What they show is that since the headline PCE rate first breached the central bank’s two percent target, in March, 2021, inflation-adjusted weekly pay (as opposed to the pre-inflation wages Powell oddly emphasizes) is actually down – by 4.60 percent. For production and non-supervisory workers (call them “blue collar” workers for convenience’s sake), real weekly wages were off by a more modest but still non-trivial 3.52 percent.

And this has propped up American consumer spending exactly how?

The Fed actually looks more closely at a wider official measure of compensation than the wage figures. It’s called the Employment Cost Index (ECI) and it takes into account salaries as well as wages, along with non-wage benefits. The ECI only comes out quarterly, and the next one, for the fourth quarter,of last year, won’t be out till January 31. But from the second quarter of 2021 (roughly when headline annual PCE inflation rose higher than that two percent Fed target) through the end of the third quarter of 2022, the ECI for private sector workers) also dropped in after-inflation terms – by 2.39 percent.

But if American workers’ pay isn’t doing much to power their still-strong consumption, what is? Obviously, the answer is mainly the excess savings piled up thanks to pandemic stimulus programs and government measures aimed at…compensating them for high inflation.

When it comes to fighting inflation, there’s good news stemming from the status of these enormous amounts of cash injected into American bank accounts: They’re being run down significantly or are just about gone for everyone except the wealthy. That no doubt explains much of the recent evidence of the cooling of the white hot levels of consumer demand that filled so many businesses with confidence that they could jack up prices dramatically are cooling, and why headline PCE is showing some signs of ebbing.

The bad news remains what it always has – that meaningfully reduced consumer spending, combined with the Fed’s continued stated determination to keep increasing the price of the borrowing that spurs so much spending, could trigger more unemployment, even worse wage trends, and a possibly painful recession.

Yet as I wrote in that above-linked RealityChek post, the $64,000 questions that will determine inflation’s fate remains unanswered: Will recession fears lead the Fed to chicken out, and at least pause its inflation-fighting interest rate increases? And will Congress and the Executive Branch decide to ride to the rescue as well, with new politically popular stimulus programs – which are likely to stimulate inflation, too?  My answer remains a pretty confident “Yes,” which is why my forecast for the economy calls for a short, fairly shallow downturn followed by a significant stretch of “stagflation” – sluggish growth and above-Fed-target inflation.   

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(What’s Left of) Our Economy: New Official Data Show U.S. Inflation is Far From Whipped

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baseline effect, core PCE, cost of living, energy prices, Federal Reserve, food prices, Gerald R. Ford, inflation, PCE, personal consumption expenditures index, recession, soft landing, Whip Inflation Now, {What's Left of) Our Economy

There’s a new reason emerging for doubting that recent official U.S. inflation figures are showing real progress being made against rising prices, and today’s release of the numbers the Federal Reserve takes most seriously are a great example. The reason? The results of previous reports – which have generated so much of the optimism (see, e.g., here) – have often been revised higher.

This morning’s data from the Commerce Department on what’s called the price index for Personal Consumption Expenditures (PCE) matter greatly. After all, the Fed is the government agency mainly responsible for keeping inflation under control. If its officials are convinced that price increases are indeed cooling significantly, they could in principle decide to stop raising interest rates and/or draining the money supply so vigorously in order to tame inflation by dramatically slowing growth and hiring.

Signs of real success, in other words, could boost the odds that the Fed’s efforts to slash consumer spending bring the economy to a soft landing – either a short, moderate growth slowdown or brief, shallow recession – rather than trigger a longer, deeper downturn. But if the Fed isn’t satisfied with anti-inflation progess, then it’s likelier to turn the clamps even tighter, and increase the chances of a painful recession or worse.

And those of you who follow the news closely know that many students of the economy (e.g., this fellow) have been insisting that inflation rates have already come down so impressively that the Fed’s stated determination to continue its restrictive policies could inflict much needless damage.

As known by RealityChek regulars, my doubts that inflation is being whipped have sprung largely from examining the baseline effect. Specfically, I look at the year-on-year results to see how they compare to those of the year before. If the former look abnormally high but the latter are abnormally low, then the most recent lofty results can be reasonably attributed to a catch up process that will simply result in price increases returning to a typical (and presumably acceptable) rate.

But if back-to-back annual inflation rates are both strong, even if these latest yearly results seem to be slowing with each passing month, then it’s just as reasonable to conclude that unacceptably high inflation retains strong momentum. And in recent months, that’s exactly what the situation has been – including today’s figures, which take the story through November.

So it’s true that November’s headline annual PCE inflation rate of 5.5 percent was the lowest since October, 2021’s 5.1 percent, and a sizable weakening from October’s 6.1 percent. But in October, 2021, when annual headline PCE was running at that 5.1 percent pace, the baseline figure headline PCE for October, 2019-2020 was 0.1 percent.

It was obvious to me, therefore, that late last year, prices were rising at rates needed to make up for the rock-bottom inflation rates of the year before, when the economy was kneecapped by the CCP Virus pandemic. That’s why I believed at that point that high inflation was “transitory.” (So did the Fed.) But it’s just as obvious that a 5.5 percent November, 2021-22 PCE inflation rate following a 5.6 percent rate between the previous Novembers means that a catch up phase has ended, and that businesses still believe they have ample scope to keep charging their customers more and more.

Adding to my concerns: That October headline annual PCE inflation rate of 6.1 percent followed a yearly rise between the previous Octobers of 5.1 percent. And then there are those revisions. That latest 6.1 percent October figure was originally reported at six even. September’s initially reported 6.2 percent now stands at 6.3. Same for August. So no one can reasonably rule out an upgrade for the November results.

The core annual PCE results tell a similar story. These data omit food and energy prices, supposedly because they’re volatile for reasons having nothing to do with the economy’s fundamental prone-ness to inflation. And the November read of 4.7 percent was the lowest since July’s identical figure, and a seemingly comforting decrease from October’s five percent.

But the baseline figure for annual November core PCE is an identical 4.7 percent – significantly higher than both October’s 4.2 percent and July’s 3.6 percent.

Moreover, upward revisions have been made recently here, too. For example, September’s initially reported 5.1 percent annual core PCE inflation is now recorded at 5.2 percent. And June’s initially reported 4.8 percent was revised up to five percent. Let’s see what the next PCE report does with today’s November figure.

The revisions have been noteworthy in the monthly PCE figures, too. November’s headline PCE rose sequentially by 0.1 percent – the best such result since July’s 0.1 percent dip, and decidedly weaker than October’s 0.4 percent. But that October result was originally pegged at 0.3 percent. Therefore, between July and October, headline PCE heated up significantly on a monthly basis. Does November signal the beginning of a sequential cooling trend? Stay tuned.

Revisions figure even more prominently in the monthly core PCE readings. November’s 0.2 percent sequential advance was also the best result since July – when it rose just 0.1 percent. It, too, was better than October’s 0.3. But October’s monthly core PCE used to be 0.2. That July advance used to be a flatline. And August’s initially reported 0.5 percent rise is now judged to have been one of 0.6 percent. So the real November figure could well be higher, too.

During the 1970s, then President Gerald R. Ford tried to deal with that era’s cost of living crisis by fostering a grassroots campaign called “Whip Inflation Now.”  Pretending today that the data are showing the anti-inflation war already won or nearly over is likely to flop just as badly. 

(What’s Left of) Our Economy: Peak U.S. Inflation Still Tough to See in Latest U.S. Figures

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Atlanta Federal Reserve Bank, core inflation, core PCE, Federal Reserve, fiscal policy, inflation, monetary policy, PCE, personal consumption expenditures index, {What's Left of) Our Economy

Even for those who don’t put much stock in using baseline comparisons, the latest official report on U.S. inflation – which covers the Federal Reserve’s preferred measure of price changes – there wasn’t much to get excited about..

The strongest evidence optimism that inflation’s peaking in this latest release on what’s called the price index for Personal Consumption Expenditures (PCE) came from the monthly results for core inflation. These strip out the food and energy results because they’re volatile for reasons supposedly having nothing to do with the economy’s fundamental prone-ness to inflation.

The latest number (for October) showed a 0.2 percent sequential rise in prices. That was one of the tamer results for the year, but it followed two straight months of 0.5 percent increases – which were among the highest results of the year. And to add a bit of insult to injury, July’s original monthly flatline figure has been revised up to 0.1 percent.

As for the monthly headline inflation result, that came to 0.3 percent in October. This increase also was one of the year’s lowest, but was the third straight month of prices rising at this rate. So a wait-and-see attitude seems to be the best that’s justified.

The annual PCE data for October was considerably less encouraging, largely because of that baseline effect. Core PCE was up five percent that month – mid-range in terms of this year’s figures. But between the previous Octobers, this inflation gauge jumped by 4.2 percent – to that point, by far the worst result of 2021.

In fact, in September of this year, when core PCE worsened by 5.2 percent, its baseline figure was just 3.7 percent.

In other words, core annual PCE inflation was getting really hot at this point a year ago. And over the course of the next year, it got hotter. And that 5.2 percent annual result for this past September has been revised up, too (from 5.1 percent).

Intriguingly, the headline annual PCE numbers reveal a very similar pattern. The bg difference: The October read of six percent matched the year’s lowest figure (from January). But the previous October annual rate was 5.1 percent – also the fastest increase that year to that point.

The September baseline figure was just 4.4 percent, and the 2022 annual headline PCE increase for that month was revised up itself – from 6.2 percent to 6.3 percent.

The bigger picture isn’t especially encouraging, either. That’s because whatever hints of inflation slowdown may be in the air surely stem from weakening momentum for the economy as a whole. (To be sure, many economists, like the Atlanta Federal Reserve’s crew, keep forecasting solid expansion continuing. But many forward-looking indicators are sending exactly the opposite message.) And as I’ve noted (e.g., here), it doesn’t take a policy genius to end inflation by tightening credit so much that growth and employment get crushed.

Further, what’s worrisome about this demand-centric approach, and continued neglect of boosting the supply of goods and services, is that when the Fed loosens monetary policy once more, or when Congress and the administration reopen the net spending spigots, or both, there will be every reason to expect strong inflation to return.

(What’s Left of) Our Economy: That New Wholesale U.S. Inflation Report was Underwhelming, Too.

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consumer prices, core inflation, cost of living, Federal Reserve, inflation, PCE, personal consumption expenditures index, PPI, Producer Price Index, wholesale inflation, {What's Left of) Our Economy

This morning saw the release of another official report on U.S. inflation that apparently everyone except me loves. It dealt with wholesale prices – what businesses charge each other to turn out the goods and service they wind up selling to their final customers. Therefore, they tend greatly to influence consumer prices down the line. And my lack of enthusiasm stems largely from the same kind of baseline considerations that bugged me about the latest consumer inflation release that delighted so many.

Not that baseline considerations weren’t my only problem with this latest read on the Producer Price Index (PPI), which covered October.

The strongest reasons for PPI optimism came from the monthly results of core PPI – which strips out food and energy prices supposedly because they change for reasons having little or nothing to do with the economy’s underlying vulnerability to inflation. (Unlike the official consumer price figures, this measure of core inflation also excludes the numbers for a category called trade services.)

October’s headline sequential core producer price increase was 0.17 percent. It was the weakest pace since July’s 0.16 percent, and revisions were big and positive for both September and August. (i.e., they went down.) Moreover, the recent monthly PPI increases are a far cry from those earlier in the year, when they peaked at 0.95 percent in March.

The story wasn’t as encouraging for the monthly headline PPI results. October’s 0.22 percent rise was only the slowest since August, when wholesale prices dipped 0.05 percent. And revisions were minimal. That means that the PPI is now up two months in a row after declining for two straight months. So where does the momentum lie? That’s not entirely clear to me.

And the year-on-year results impressed me even less because the comparisons with the previous year make clear that on this basis, producer inflation has lots of momentum.

Take core PPI. October’s annual increase of 5.38 percent was not only a nice step down from September’s downwardly revised 5.61 percent. It was the most sluggish pace since May, 2021’s 5.25 percent. But between the previous Mays, prices had actually sagged by 0.18 percent – because of the economy’s big CCP Virus-induced downturn. So the May, 2020-2021 number looked to me like nothing more than a return to normal (and in fact, such considerations convinced me for many months that recent price increases would indeed be transitory).

But the October annual PPI increase was coming off an October, 2020-21 spurt of 6.26 percent. By contrast, when annual PPI crested this year, at 7.11 percent in March, the baseline figure was just 3.15 percent – only about half as high. That tells me that businesses last month believed they still had plenty of (inflationary) pricing power despite their great success in charging their customers much more over the previous twelve months.

The headline annual results look very similar, with one notable exception. The October yearly PPI increase of 7.97 percent was both much lower than September’s downwardly revised 8.44 percent and the best such result since July, 2021’s 7.83 percent. But as with the core PPI figures, that increase was coming off a pandemic-y wholesale price decrease of 0.17 percent between the previous Julys.

And when headline annual PPI inflation topped out this year (so far) at 11.67 percent in March, that increase followed an annual rise between the previous Marchs of 4.06 percent. The latest October annual increase follows an October, 2020-21 jump of 8.90 percent – more than twice as high. So that’s another sign that businesses remain awfully confident about their pricing power – and that companies that supply consumers will be faced with major cost increases for months to come.

Moreover, as I’ve pointed out, those consumers still have lots of money to spend, and will receive more in the near-term future. So it’s likely that they’ll keep paying up for the time being however much they may grumble. Until serious signs appear that they’re getting tapped out, keep expecting inflation to stay alarmingly high, too. 

P.S. The next official U.S. inflation report comes out December 1, and it’s the Federal Reserve’s favorite measure of consumer price trends.  Stay tuned!

(What’s Left of) Our Economy: Too Much Irrational Exuberance Today on U.S. Inflation

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consumer price index, core CPI, CPI, Federal Reserve, inflation, interest rates, monetary policy, personal consumption expenditures index, Producer Price Index, {What's Left of) Our Economy

Wall Street is ecstatic about today’s official report on two measures of consumer inflation, and President Biden is pretty pleased, too. Both see improvement in the October results for both overall (headline) inflation, and for core inflation (which strips out food and energy prices supposedly for reasons that have nothing to do with the economy’s underlying inflation prone-ness).

And both evidently believe that this improvement means that the Federal Reserve will start easing off on the interest rate hikes it’s both approved so far and promised in order to bring price increases down from their recent multi-decade-worsts. In other words, if inflation is moderating, the Fed might not have to slow down economic growth and job creation as much as feared in order to restore price stability.

Here’s why I think both are wrong – or at the very least prematurely optimistic. They’re ignoring that baseline effect. If you look at the data in context, you see that the annual increases in both the headline and core readings for the Consumer Price Index (CPI) are both coming off prices rises that were highs for the previous year, and that heated up considerably between September and October.

Specifically, although the year-on-year rise of headline CPI did slow to its weakest rate (7.76 percent) since January, the previous year’s annual October overall consumer price increase was that year’s fastest (6.24 percent). The new yearly annual CPI increase was indeed cooler than September’s (8.22 percent). But that figure was coming off a 2020-2021 rise of just 5.39 percent.

Core inflation displayed a similar pattern. In October, prices of goods and services excluding food and energy rose by 6.31 percent at an annual rate – down from a September increase of 6.66 percent that was the worst such figure since August, 1982 (7.06 percent). But the previous September, core annual inflation was 4.04 percent. The previous October, it was a considerably higher 4.59 percent.

The best interpretation, as I see it? Businesses still have plenty of pricing power, which will keep inflation dangerously high, because consumers still have plenty of spending power.

Such inflation pessimism (especially if the Fed does ease off its tightening policy) is also supported by the monthly headline CPI numbers. Overall prices climbed sequentially by 0.44 percent in October. That was way off the high for this year (March’s 1.24 percent). But it represented the third straight speed up.

The news was much better for core monthly CPI. The October rise of 0.27 percent was the year’s slowest, and down greatly from September’s 0.58 percent.

But that core performance bears careful watching, too, because energy prices in particular tend to influence consumer prices eventually, since energy is a key cost for virtually every good and service produced in America. In fact, month-to-month, energy prices were up 1.8 percent in October after falling 2.1 percent in September.

In that vein, another clue about future inflation rates is coming next Tuesday, with the release of the new producer price report. That measures what companies charge each other for the purchases needed to turn out whatever they provide to consumers and to each other (if businesses are their final market). And don’t forget: The CPI isn’t the Fed’s favorite gauge of inflation. It looks more closely at the price indices for “Personal Consumption Expenditures,” and these October results come out December 1.

These clues, however, even if taken all together, won’t be all that big for inflation-watchers, as they’ll cover just a single month.  As Fed Chair Jerome Powell stated earlier this month, the central bank is going to need to see “a series of down monthly readings,” and much other evidence, before concluding that inflation is “coming down decisively.”  Although he really was behind the curve is foreseeing how prices would shoot up, waiting for the trends over time to start appearing seems like by far the best inflation-fighting approach now.  And why the markets’ reaction to today’s data seems like what one of Powell’s predecessors called  “irrational exuberance.” 

(What’s Left of) Our Economy: New Official Figures Show Continued Blazing U.S. Inflation

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consumer price index, core inflation, cost of living, Federal Reserve, inflation, PCE, personal consumption expenditures index, Producer Price Index, recession, {What's Left of) Our Economy

Today’s new release covering September makes it two straight lousy official reports on the Federal Reserve’s preferred measure of U.S. inflation – the price index for Personal Consumption Expenditures (PCE). At least as bad: The new figures come on top of lousy September reports on the Consumer Price Index and on price increases at the wholesale level (the Producer Price Index).

The latter, of course, usually feeds future inflation at the consumer/retail level as long as businesses retain pricing power – which is clearly still the case because of all the cash households still have to spend due to humongous stimulus legislation and the Fed’s own historically off-the-charts efforts to juice the economy during the CCP Virus era.

The worst result from today’s PCE report came in the annual core numbers. They leave out food and energy prices, (supposedly because they’re volatile for reasons having little or nothing to do with the economy’s fundamental inflation prone-ness), and rose for the second straight month, from 4.9 percent to 5.1 percent. That’s the fastest increase since March’s 5.2 percent.

The best thing that can be said about the other September numbers is that they didn’t rise above multi-decade highs.

Headline PCE inflation stayed at the 6.2 percent it registered for August. It’s down from June’s peak of seven percent, but still way above the Fed’s target rate of two percent.

On a monthly basis, headline PCE increased by 0.3 percent in September and core PCEn by 0.5 percent. Both matched the August rates, too. The overall PCE advance was much better than its peak of one percent (also hit in June). But as recently as July, headline PCE dipped by 0.1 percent. So that actual deflation looks like a mere blip now.

Core PCE reveals a similar pattern. Month-to-month its high came in June as well, at 0.6 percent. In July, it flat-lined but has since rebounded strongly.

At this point, moreover, the only reasonable forecast for the foreseeable future is more towering inflation – and not just because most consumers’ finances are in very good shape. There are also all the new federal boosts to demand in the form of student loan forgiveness, the annual Social Security cost-of-living increase (justified, of course, by high inflation), and now the prospect that the Federal Reserve will indeed chicken out on the inflation-fighting front for fear of tipping the economy into recession. (For the record, I’m surprised at how far down the interest rate hike road the central bank has gone.)

In other words, consumer spending power looks certain to remain strong, and government could well back off from biting the bullet and taming inflation by choking off growth in order to limit that spending. (Serious efforts to employ the other fundamental inflation-fighting tactic, boosting production and therefore the supply of goods and services to close the gap with demand, appear off the table for now as well.) The only big uncertainty that’s left continues to be how long this party can last.      

(What’s Left of) Our Economy: Why Peak Inflation Claims Should Finally Peak

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Biden adminstration, core PCE, energy prices, Federal Reserve, food prices, food stamps, inflation, PCE, personal consumption expenditures index, student loans, {What's Left of) Our Economy

Here’s how bad today’s official report on the Federal Reserve’s preferred gauge for U.S. inflation was: It looked awful even without taking the baseline effect into account. That is, it looked awful even if you don’t examine how the new (August) year-on-year increases compare with both their predecessors and those for the preceding year, and understand that the 2021-22 numbers are coming off 2020-21 results that were alarmingly high to begin with,

Yes, the annual increase in August in the headline version of the Fed’s favored price index for Personal Consumption Expenditures (PCE) dipped from 6.4 percent in July to 6.2 percent. But by last August, it had already climbed to 4.2 percent – more than twice the Fed’s target rate.

Worse, though, was the acceleration in the August annual core PCE read from 4.7 percent to 4.9 percent . These are the figures that leave out food and energy prices – supposedly because they’re volatile for reasons that have nothing to do with the economy’s underlying inflation prone-ness.

Inflation optimists had seized upon the June-July drops in the headline PCE (from seven percent to 6.4 percent and from five to 4.7 percent, respectively) as a major sign that price increases had peaked. The August statistics seem to throw frigid water on that conclusion.

Worse still was the speed up in both inflation indicators on a monthly basis. Headline PCE had actually fallen sequentially in July by 0.1 percent, but in August it rose by 0.3 percent. And that’s despite energy prices nosediving (by fully 5.5 percent on month) both because towering gasoline prices had forced many Americans to cut back on driving, and because the rest of the world economy is seeing dramatically reduced growth, which depresses energy demand.

Replacing energy as a major cost-of-living driver were food prices, which were up month-to-month by 0.8 percent. So unless you think energy prices will keep sinking like a stone, it’s become tougher to stick with the peak inflation claims.

But the biggest blow to the peak inflation case came from the monthly core results. Even omitting those volatile food and energy prices, core inflation jumped by 0.6 percent between July and August, after flatlining between June and July. And this new August monthly hike ties June’s for the year’s worst.

And I’d be remiss in closing without mentioning two recent Biden administration steps sure to buoy inflation still further – the student loan forgiveness plan (even – if it survives legal challenges – in its new scaled back form) and his big expansion of food stamp benefits (prompted at least in part, and ironically, due to those huge food price increases). Whatever you think of the merits of these programs, their net effect inevitably will put more income in consumers’ pockets and thus support spending while doing nothing to increase production. That is, as economists like to say, more money will be chasing the same amount of goods and services – an inflation-fueling formula no thinking person disputes.

(What’s Left of) Our Economy: The Worst of All Possible Inflation Worlds for U.S. Workers?

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ECI, Employment Cost Index, Federal Reserve, inflation, Jerome Powell, Labor Department, labor productivity, PCE, personal consumption expenditures index, productivity, recession, stagflation, wages, workers, {What's Left of) Our Economy

The newest report on a key official measure of worker compensation has just shown that, during today’s high inflation era, American workers could be both significantly fueling the soaring prices that are dominating the U.S. economy and getting shafted by them.

This measure – called the Employment Cost Index – is tracked by the Department of Labor, and is watched closely by the Federal Reserve (the government’s chief inflation-fighting agency) for two major reasons. First, it includes not just wages, but salaries and non-cash benefits. Second, unlike the Labor Department’s average wage figures, it takes into account what economists call compositional effects.

In other words, the those wage figures report hourly and weekly pay for specific sectors of the economy, but they don’t say anything about labor costs for businesses for the same jobs over time. The ECI tries to achieve this aim by factoring in the way that the makeup of employment between industries can change, and the way that the makeup of jobs within industries can change (e.g., from a majority of lower wage occupations to one of higher wage occupations).

In his press conference last Wednesday following the Federal Reserve’s announcement of a second straight big increase in the interest rate it controls directly, Chair Jerome Powell mentioned that the ECI report coming out on Friday would greatly influence the central banks’ decision on how much more tightening of credit conditions would be needed to slow the economy enough to cool inflation acceptably.

That’s because, as he has explained previously, the supposedly superior insights on worker pay provided by the ECI enable the Fed to figure out whether a major inflation engine has started to rev up – employee compensation rising faster than worker productivity. Industries (or entire economies) in this situation are denied the option of absorbing wage increases by achieving greater efficiencies in their operations Therefore, they face more pressure to maintain earnings and profits by passing pay increases onto their customers, their customers face more pressure to keep up with living costs by pushing for pay hikes themselves, and what economists term a classic and hard-to-break wage-price spiral takes off.

The new ECI results per se looked alarming enough from this perspective. They showed that between the second quarter of 2021 and the second quarter of 2022, total employee compensation for the private sector ose by 5.5 percent. That’s the fastest pace since this data series began in 2001. Moreover, this record represented the third straight all-time high. (RealityChek regulars know that private sector numbers are the most important gauge, since its pay and other indicators are mainly driven by market forces, unlike the statistics for government workers, where the indicators largely reflect politicians’ decisions.)

Sadly, though, according to the Fed’s favorite measure of consumer inflation (the Commerce Department’s Personal Consumption Expenditures price index), living costs increased by 6.45 percent. So workers fell further behind the eight ball.

Perhaps worst of all, however, productivity growth is in the toilet. We won’t get the initial second quarter figures until September 1, but during the first quarter, for non-farm businesses (the most closely followed measure for the private sector), it fell year-on-year by 0.6 percent – the worst such performance since the fourth quarter of 1993.

Nor was this figure a one-off for the current high inflation period. From the time consumer prices began their recent speed up (April, 2021) through the first quarter of this year, labor productivity is off by 1.36 percent, the ECI is up 3.95 percent, and PCE inflation has risen by 4.65 percent. So a strong case can be made that workers, businesses, and the economy as a whole are in the worst of all possible worlds.

Whenever productivity is the subject, it’s important to note that it’s the economic performance measure in which economists probably have the least confidence. And even if it’s accurate, don’t jump to blame workers for sloughing off. Maybe management is doing a lousy job of improving their productivity. Alternatively, maybe managers simply haven’t figured out how to do so in the midst of so many unusual challenges posed by the pandemic and its aftermath – chiefly the stop-go nature of the economy’s early aftermath, and the resulting turbulence that, along with the Ukraine war and China’s Zero Covid policy, is still roiling and stressing supply chains.

Whatever’s wrong, though, unless a course correction comes soon, it looks like the odds of the economy sinking into prolonged stagflation – roaring inflation and weak economic growth – are going up. And ultimately, that matters more to the American future than whether some form of recession is already here, or around the corner.

(What’s Left of) Our Economy: Another Dreadful U.S. Consumer Inflation Report

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Commerce Department, consumer price index, consumers, core inflation, cost of living, CPI, demand, energy, Federal Reserve, food, inflation, Labor Department, monetary policy, PCE, personal consumption expenditures index, prices, supply chains, Ukraine War, Zero Covid, {What's Left of) Our Economy

Optimism about U.S. inflation took another blow yesterday morning – though it shouldn’t have been unexpected – with the release of the latest data on the Federal Reserve’s favorite measure of price changes. I said “shouldn’t have been unexpected” because, as Fed Chair Jerome Powell and others have noted, this gauge and the higher profile Consumer Price Index (CPI) put out by the Labor Department normally track each other pretty closely over the long run, and those CPI results were deeply discouraging.

Nonetheless, latest results from the Price Indexes for Personal Consumption Expenditures (PCE) monitored by the Commerce Department matter because they strongly confirmed the latest CPI figures – which were pretty awful – starting with the month-to-month changes for the entire economy.

In June, headline PCE inflation shot up sequentially by a full one percent – much faster than May’s 0.6 percent and indeed the fastest rate not only throughout this latest high-inflation period, but the fastest since it increased by one percent in September, 2005.

But another observation should make even clearer how unusual that monthly headline increase was. The Commerce Department has been keeping these data since February, 1959. That’s 749 months worth of results through last month. How many times has monthly headline PCE inflation been one percent or higher? Twelve. And the all-time record is just 1.2 percent, hit in March, 1980, and February and March, 1974.

The annual figures were no better, and RealityChek regulars know that they’re more reliable than the monthlies because they measure changes over a longer time period, and therefore smooth out short-term fluctations.

June’s 6.8 percent rise was the strongest of the current high inflation era, and a significant pickup from May’s 6.3 percent. And it looks even worse when the fading baseline effect is taken into account. The June yearly jump in headline PCE came off a June, 2020-21 increase of four percent. So that year’s June PCE rate was already twice the Federal Reserve’s two percent annual inflation target.

By comparison, headline PCE this March was only a little lower than the June result – 6.6 percent. But the baseline figure for the previous March was only 2.5 percent. That rate was still higher than the Fed target, but not by much. So arguably unlike the price advances of June, this March’s inflation reflected some catching up from price increases that were still somewhat subdued due to the economy’s stop-go recovery from earlier during the pandemic.

Core PCE was lower by both measures, because it strips out the food and particularly energy prices that have spearheaded much headline inflation, and that are excluded supposedly because they’re volatile for reasons having little to do with the economy’s fundamental vulnerability to inflation. But here the monthly figures revealed new momentum, with the June seqential increase of 0.6 percent twice that of May’s 0.3 percent, and the highest such number since May and June of 2021.

Before then, however, core inflation hadn’t seen a monthly handle in the 0.6 percent neighborhood since September and October of 2001, which registered gains of 0.6 and 0.7percent, respectively.

On an annual basis, June’s core PCE increase of 4.8 percent was slightly higher than May’s 4.7 percent, but well below the recent peak of 5.3 percent in February. But the baseline effect should dispel any notions of progess being made. For June-to-June inflation for the previous year was 3.5 percent – meaningfully above the Fed’s two percent target. Core annual PCE inflation for the previous Februarys was just 1.5 percent – meaningfully below the Fed target.

As with most measures of U.S. economic perfomance, an unprecedented number of wild cards that can affect both PCE and CPI inflation has rendered most crystal balls (including mine) pretty unreliable. To cite just a few examples: Will China’s Zero Covid policy keep upending global supply chains and thus the prices of Chinese exports? Will the ongoing Ukraine War have similar impacts on many raw materials, especially energy? Will the Federal Reserve’s tightening of U.S. credit conditions per se bring inflation down significantly in the foreseeable future by dramatically slowing the nation’s growth? Will high and still soaring prices, coupled with vanishing savings rates, achieve the same objective if the Fed’s inflation-fighting zeal wanes? Or will the still huge amounts of money in most consumers’ bank accounts along with continuing robust job creation keep the demand for goods and services elevated for the time being whatever the Fed does?

Here’s what seems pretty certain to me: As long as that consumer demand remains strong, and as long as producer prices keep jumping, businesses will pass these rising costs on to their customers and keep consumer inflation worrisomely high. That seemed to be precisely the case in the last two months, with a torrid May read on producer prices being followed by the equally torrid June consumer inflation reports. So unless this wholesale inflation cooled a great deal this month, I’d expect at least another month of red hot consumer inflation. That producer price report is due out August 11.

(What’s Left of) Our Economy: The Real Message Behind the New U.S. Inflation Figures

Tags

bubbles, consumer price index, core PCE, CPI, energy, Federal Reserve, inflation, Jerome Powell, monetary policy, PCE, personal consumption, personal consumption expenditures index, productivity, recession, {What's Left of) Our Economy

There – that wasn’t so hard, was it? Meaning that if a national government (including its central bank) wants to get inflation down, it’s not a rocket science-type challenge. Elected officials (or dictators) can cut public spending, monetary authorities like America’s Federal Reserve can tighten monetary policy, and voila. Receiving less financial juice, consumers stop consuming so much, businesses stop investing and hiring so robustly, and the lower level of economic activity begins depriving sellers of pricing power – at least if they want to keep their sales up. 

Moreover, these governments can enjoy the benefits of a venerable economic adage: an effective cure for high prices is high prices. That is, at some point, regardless of government policies, goods and services begin getting unaffordable. So businesses and consumers alike don’t buy so much of them, and the reduced demand also forces sellers that want to keep sales up to start marking them down.

At least that’s a message that’s easy to take away from the today’s new official report on U.S. “Personal Income and Outlays,” which, as usual, contains data on price increases and consumer spending, and which shows a softening in both.

Before delving into the specifics, however, it’s important to point out that (1) less economic activity means less prosperity – and in many instanaces can mean much worse – for most of the population; and (2), the higher inflation has become, the more belt tightening is needed, and the more economic suffering must be imposed, in order to bring it to levels considered acceptable. And since the new, better numbers from Washington still reveal price increases near multi-decade highs, it figures that returning to satisfactory inflation will require many Americans to experience significantly more economic pain.

In other words, the “soft landing” that Fed officials in particular describe as the goal of their anti-inflation policy – that is, taming inflation while still fostering some growth – still looks like much less than a sure bet. Even Fed Chair Jerome Powell acknowledges this.

Powell and many others insist that even if the landing is hard, the anti-inflation medicine will be necessary, since, in his words, “Economies don’t work without price stability.” Often they add that the steps necessary to defeat inflation will also help cure the economy of its long-time addiction to bubble-ized growth – that is, prosperity based on credit conditions that are kept way too loose, that deprive producers of the market-based disciplines needed to keep prosperity sustained, and that in fact spur so many bad and even reckless choices by all economic actors that they inevitably end in torrents of tears.

I’m sympathetic to these arguments, but the main point here is that killing off inflation per se has always been first and foremost a matter of will – which has clearly been lacking for too long. Avoiding recession, conversely, is no great accomplishment, either: Just keep inflating bubbles with easy money. It’s fostering soundly based, sustainable growth that’s been the challenge that American leaders have long failed to meet.

As for the specifics, let’s start with the inflation figures contained in today’s report from the Commerce Department. They’re somewhat different from the more widely covered Consumer Price Index (CPI) tracked by the Labor Department, but this Personal Consumption Expenditures (PCE) price index matters a lot because it’s the inflation measure favored by the Fed, which has major inflation-fighting responsibilities.

On a monthly basis, “headline” PCE inflation (the broadest measure) bounced up from April’s 0.2 percent (the weakest such figure since the flatlline of November, 2020) to 0.6 percent (the worst such figure since March’s 0.9 percent). The “core” figure (which strips out food and energy prices supposedly because they’re volatile for reason largely unrelated to the economy’s fundamental vulnerability to inflation), increased sequentially in May by 0.3 percent for the fourth straight month. Those are the smallest such increases since September, 2020’s 0.2 percent.

These results are one sign that spending has fallen off enough to prevent still strong energy inflation from bleeding over into the rest of the economy – just about all of which uses energy as a key input. And indeed, the new Commerce release reports that adjusting for inflation, personal consumption fell on month (by 0.4 percent) for the first time since last December (1.4 percent).

As known by RealityChek regulars, the annual rates of change are usually more important than the monthly, because they gauge developments over longer time periods and are therefore less likely to be thrown off by short-term developments or sheer statistical randomness. And encouragingly, they tell a similar story. The headline annual PCE inflation rate of 6.3 percent was the same as April’s, and lower than March’s 6.6 percent. Annual core PCE inflation dropped to 4.7 percent from April’s 4.9 percent and hit its lowest level since last November’s 4.7 percent – another sign that because consumers have pulled back, hot inflation in energy isn’t stoking ever stronger price rises elsewhere.

No one could reasonably call today’s inflation report “good” – especially since the baseline effect (which RealityChek readers know throughout 2021 produced annual inflation rates that were unusually high because of a catch-up effect from the unusually low inflation results of 2020) is gone. In other words, price increases much higher than the Fed’s two percent target rate are persisting.

But to this point, anyway, these increases aren’t coming faster – which is crucial because one reason inflation is so feared is its tendency to feed upon itself.

As pointed out above, though, weakening inflation by tanking the economy is no great triumph of economic policy. Worse, it’s all too easy to conclude from recent history that, even though a recession hasn’t officially arrived, once it does, most politicians will rev up the spending engines again, and (successfully) pressure the Fed to at least stop the tightening. And inflation will take off again. 

There’s a much better inflation-fighting alternative that’s available, at least in principle:  Increase the nation’s sagging productivity growth.  Boosting business’ efficiency enables companies to deal with cost increases — including wage hikes — without passing them on to consumers.  But a productivity rebound seems nowhere in sight, seemingly leaving the nation stuck in a pattern of blowing up bubbles to achieve periods of acceptable growth and employment, popping them at least occasionally to keep prices in check, and hoping the whole Ponzi scheme can somehow continue indefinitely.