The chance of a soft landing in the American economy increases – 06/24/2023 – Samuel Pessôa

I always thought that the current disinflation process in the US would require some pain. The calculation is relatively simple: after the reversal of the shocks linked to the pandemic and the war in Ukraine, inflation would be around 4% to 5%. Given the 2% target, the disinflation produced by monetary policy should be around two percentage points (pp).

A 2 pp reduction in inflation demands a 2 pp rise in the unemployment rate and, given the relationship between unemployment and activity, an accumulated reduction in growth, relative to potential, of 4 pp, over an 18 or 24 month horizon .

The job of monetary policy would be to bring about a deceleration in growth and create a sufficient gap for the unemployment rate to rise from approximately 3.5% to 5.5%.

Three facts have suggested that perhaps the US disinflation process is less painful than I initially imagined. First, the component of consumer inflation given by services excluding rents and electricity bills has shown strong moderation. It dropped from 6.6% a year in September to 5.5% in May. In the last three months, it ran at 2.3% in annual terms.

Second, the consumer survey conducted monthly by the University of Michigan points out that consumer inflation expected for the next 12 months is 3.3%. The data is still preliminary, on the 30th we will know the definitive numbers, but it is great news for disinflation. Consumer expectations generally overestimate inflation by one percentage point. Expectation of 3.3% is almost on target.

Third, the growth rate of nominal wages per hour worked, which ran at 6% per year at the beginning of 2022, is now at 4.5%. At this rate, in one year we will have something between 3% and 3.5% in nominal wages, a value compatible with the inflation target of 2% per year and an increase in labor productivity of 1% per year.

In other words, perhaps this time it will be different and we will observe a much less painful disinflation in the US than in other post-war episodes. What has changed?

The new fact is that this is the first disinflation that occurred under the inflation targeting regime. Throughout the entire process of reinflation of the American economy – which has been taking place since 2021 –, there has been no breach of confidence in the system. That is, inflation expectations five or ten years ahead have not risen.

Indeed, recent work by former US central bank chairman Ben Bernanke with former IMF chief economist Olivier Blanchard suggests that there is room for painless disinflation.

Three factors in their estimates indicate this possibility: 1) low inflation inertia; 2) workers’ low ability to pass on salary losses; and 3) residual inflation, following the reversal of all price shocks since 2020, is only 3% (one percentage point less than expected).

If, in fact, there is a painless disinflation, we should expect an anticipation of the basic interest rate decline cycle in the American economy.

The rapporteur for the tax reform of indirect taxes —ISS, ICMS, PIS/Cofins and IPI—, Deputy Aguinaldo Ribeiro (PP-PB), presented his text on Thursday (22). This is great news. Tax simplification is the most important reform we have for raising the rate of labor productivity growth. I dealt with the theme in the February 25 column entitled “Lula’s Real 3”.

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