Themes From A Busy Year

Reputation Disinflation

Economists have to learn to live with volatility, but our reputation has gone to extremes over the past twelve months. Last year, our team won a prestigious forecasting award; this year, we were a long way off. The distance between the penthouse and the doghouse for us was, unfortunately, quite short.

The bane of our existence has been inflation, which went from dormant to dominant. Supply chains proved more brittle than anticipated; the invasion of Ukraine, unforeseen at the beginning of the year, roiled energy and commodities markets. An unexpected and unwanted surge in home prices pushed shelter costs up. And labor shortages persisted, pressuring the prices of basic services.

Month after month, forecasters declared that inflation had peaked, only to witness further escalation. But the worst may finally be in the past. In major markets, inflation is either near or past its zenith, and we think that it will decline somewhat more sharply from here than others do. Energy costs are 50% below their midsummer peaks, house prices are falling and mended supply chains are producing an excess of inventory.

From a top down perspective, central bank tightening has restrained money supply growth (which is actually declining in the United States). Large and small firms are reporting less freedom to raise prices; after a post-pandemic splurge, consumer frugality may once again serve as a secular governor on inflation. Recession is coming to Europe and may visit the United States, taking an edge off demand.

If we are finally right, we will have avoided disrupting the rational inattention that workers have applied to inflation. Had they incorporated recent conditions more completely into their compensation demands, a wage-price spiral could easily have formed.

We had a lot of company in our miscalculations, but that carried little weight with my boss. He has sardonically referred to the persistent price level increases as the “Tannenbaum transitory inflation.” I fear that designation may stay with me long after our forecast accuracy improves.