Transcript:
Rick Brink: So, Eric, obviously inflation [is] arguably the most dominant topic in the economy and capital markets today. There’s a lot we could say, but we’re going to focus on five key questions. You ready?
Eric Winograd: Yep.
Rick Brink: Okay. Number one, what makes pandemic inflation so unique?
Eric Winograd: In a normal recession, monetary policy does the heavy lifting by cutting interest rates, by pushing liquidity through the financial system and into the supply side of the economy. Meantime, the demand side suffers because households lose employment, people’s incomes go down. And so fuel for consumption really isn’t there. And the net result is that as the economy starts to recover, supply is above demand and that tends to correlate with sluggish prices.
In this crisis, of course it was the opposite. Monetary policy couldn’t do the heavy lifting because pushing money through the financial system into the corporate sector, wouldn’t do any good. Businesses had to be closed for public health reasons. And the real need for financial help was on the household side, where from a public health perspective, we needed people to be able to socially distance, but [we] also needed people to be able to eat. And so fiscal policy put a lot of money into people’s pockets. And of course, what that has meant is that when the economy reopened, the fuel for consumption is there. And so demand has been above supply. And so instead of sluggish price pressures, we’re seeing the opposite.
Rick Brink: Which leads me to question number two. Why did the Federal Reserve retire the word transitory?
Eric Winograd: There’s two meanings of the word transitory, of course. One is temporary or short term. And I think that’s what most people heard when the Fed said transitory, and took that to mean they expected inflation to be short-lived. The second meaning though, is impermanent, simply meaning that it won’t do durable damage to the economy, that over time things will go back to some sort of normal. I think the Fed is trying to pivot the discussion correctly to not what inflation is doing now, or even what it’ll do for the next couple of months, but what the new normal is going to look like. When we sit here a year from now, what will we be looking at when it comes to prices and to inflation? And that’s really where the discussion needs to go.
Rick Brink: And so that’s where our discussion is going to go. So let’s go to question number three. What is the new normal for inflation?
Eric Winograd: There’s a lot of uncertainty around what that new normal looks like. And you can come up with a lot of plausible scenarios. Our basic expectation is that inflation will come down from where it is now. I don’t think it’s very likely that we’ll be talking about 4% or 5% [or] 6% per year price increases for very much longer. I think we’ll be able to measure that in months rather than in years.
But I think there’s a good case to be made that at some of the reasons inflation has been persistently low over the course of the last decade are also fading. And so, we’re not expecting inflation to go back to the pre-crisis norm of 1 1/2% to 2% either. We think it’ll settle somewhere in-between. And for the next year, we’re looking at somewhere between 2 1/2% and 3%. And then over the longer term, probably between 2% and 2 1/2% instead of the 1 1/2% to 2% that we’d become accustomed to.
Rick Brink: And then that naturally segues into question number four, which is if that’s the base case, then there’s got to be an upside and a downside. Why don’t we talk about both of those?
Eric Winograd: The risks around the inflation forecast are largely driven by the underlying components of inflation. You can group them broadly into goods inflation and services inflation. And right now those are on very different paths. Goods inflation has very clearly been impacted by the pandemic. Goods travel long distance. They’re subject to supply-chain volatility. The further they have to travel and the harder it is for them to travel, the more expensive they’re going to be. There are shortages of key goods, and semiconductors being the best example of that. And that has pushed goods price inflation to roughly 10% over the course of the last year, which is dramatically higher than anything we’ve seen in multiple decades. Indeed, pre-pandemic goods price inflation was running at roughly 0%. So it’s a big, big change.
Over time, I think that that will come off the boil. As we see supply-chain bottlenecks ease, we would expect the transport of goods and the supply of goods to ease up a little bit and for those prices to stabilize. And that, if they do behave in that fashion, should pull overall inflation lower. If there’s an overcorrection, if businesses overinvest in key goods that are difficult to source right now, as a result of the robust demand, that could pull prices down. And to me, that’s the real downside driver is if you end up with coming out of a period of low supply into a period of high supply over the course of the next few years.
The upside risks though have to do with services inflation, which have been more stable, but are now starting to look a little bit perky. You have many service industries that are high touch industries, that require a large number of employees. And of course, wages are going up in a lot of industries right now. That should, over time, push services inflation higher. And of course, the key component there is rental income and housing related. House prices are up quite dramatically. Rental incomes are starting to follow. And over time we expect that the shelter components of inflation will also move higher.
Rick Brink: And so if we take that and sum it up, basically the idea is that inflation going forward is probably lower than it is now, but higher than it was pre-pandemic. There’s a case to be made for it being higher and a case to be made for it being lower. So if I’m trying to keep an eye on things over the next 12 months, what am I looking out for?
Eric Winograd: Normally, it’s pretty easy to know what you’re supposed to look at, right? You’re supposed to look at prices as they to come in and have a sense of it. It’s more complicated now because the things we’re looking at aren’t entirely data-related. We are looking at supply chains as a key driver of this. The faster that supply-chain bottlenecks unwind, the faster and more powerfully we expect disinflation through goods prices. So we’re tracking things like the number of container ships backed up at the ports. We’re making use of alternative data sources in a way that is really, really interesting for what it’s worth, but that is different than the way we would traditionally look at inflation, because it measures things like freight traffic in a way that traditional data sources don’t. So we’re looking at that very carefully. We’re looking at inflation expectations as well.
Inflation expectations have a way of becoming self-fulfilling. If you expect the price of something to go up next week, you have an incentive to buy it today. If you buy it today, that increases demand for it. Right? And again, if demand goes up and supply is static, prices go up. So the more you consume today, the more likely it is that the price increase you are worried about tomorrow actually happens, right? So we are watching inflation expectations, very closely. They have gone up in a lot of cases.
The good news is they seem to have gone up primarily over the short term. So, if you ask people, “What do you expect inflation to be in the next year?” They’ll tell you that it’s elevated. If you ask, “What do you expect it to be over the next three to five years?” The answer really isn’t very different than it was pre-crisis. So it seems to us, at least, that consumers are generally expecting inflation to be, and here comes that word again, transitory, in the sense of not having done permanent damage to the price setting mechanism.
Rick Brink: Great. Thanks, Eric. Thanks for all your answers.
Eric Winograd: Thank you.