As 2023 draws to a close, there are many known unknowns – especially on the geopolitical front – and presumably as many unknown unknowns lurking on the horizon. Producing any forecast for the global economy is thus more difficult than usual. For their part, investment houses seem to be expecting a further slowdown in 2024, with many flummoxed by the fact that we haven’t had a major slump already.
The inflation outlook poses an even bigger challenge. The past few years have shown that inflation can be heavily affected – at least on a headline basis – by uncertainty and unknown unknowns that make themselves known. A heated debate about the inflation outlook is ongoing, with some highly respected and very experienced businesspeople expressing doubts that central banks have got the problem under control. The latest consumer price data for the eurozone, the United States, and the United Kingdom offer some encouraging news about headline inflation trends; but core inflation (excluding volatile energy and food prices) remains uncomfortably above central banks’ target rates.
Of course, the world’s second largest economy, China, does not seem to have this problem. On the contrary, its most recent consumer-price data show that it is experiencing deflation, with its core consumer price index falling by 0.5% (on an annual basis) in November. There once was a time when many analysts suspected that China was transmitting deflationary pressures to the rest of the world, primarily through its low-cost manufacturing export and their increased market share in foreign markets. If we were still in that era, some of the current inflationary fears might be lessened. But those days are gone, it seems.
“A heated debate about the inflation outlook is ongoing, with some highly respected and very experienced businesspeople expressing doubts that central banks have got the problem under control. ”
The scale of China’s domestic economic challenges – deflation included – is a massive question deserving of its own commentary. Given the issues facing its property market, judging by similar experiences in other countries, one can assume that its difficulties will be prolonged. But a less pessimistic view is that Chinese policymakers are fully aware of those issues, owing precisely to those previous cases, as well as the warnings that various commentators have been issuing for quite some time.
In addition to Chinese domestic factors, one also must consider the trends for global commodity prices, over which Chinese demand will remain a big influence. Here, the news toward the end of 2023 has been more encouraging than many would have expected, and suggests that headline inflation in many countries could fall further in the coming months. Despite the chaos in the Middle East and the war in Ukraine, crude oil prices remain soft, surprising many analysts – including some who should know that this market is nothing if not unpredictable.
Beyond these factors, three others stand out for me. First, monetary growth has weakened sharply in many economies, which is quite reassuring when combined with current commodity-price trends. While it has been a long time since anyone other than the most ardent monetarists claimed that money supply always bears directly on inflation, the past few years have shown that if monetary growth accelerates radically (as it did in late 2020 and early 2021 in the US), inflation can rise.
Second, and perhaps in line with the commodity and monetary trends, recent measures of inflation expectations in key countries have been reassuring. In particular, the latest University of Michigan survey of consumers’ five-year outlook showed a sharp drop, to 2.8%, from 3.2% the previous month, indicating, at a minimum, that no sustained increase or “un-anchoring” of long-term inflation expectations is taking place.
The final, and perhaps trickiest, question is how central banks will respond. In its latest forward guidance to markets, the U.S. Federal Reserve Board suggested that interest rates would be cut by 75 basis points in 2024. Other central banks however, especially in Europe, are pushing back on financial markets’ bet that interest rates will be cut next year, but markets do not seem to have gotten the memo. With core inflation still above target, real (inflation-adjusted) wages growing, and strong evidence of productivity growth nowhere to be seen, central bankers will be loath to cut rates soon. But as they continue to try to influence markets with their guidance and public statements, they will have to accept that markets – in their collective wisdom – may see something that they themselves do not. If the data take a sharp favorable turn, they will probably change their tune.
Wage growth remains a crucial variable. In some countries, especially the U.K., it is finally outpacing consumer-price growth. Policymakers instinctively will worry that this trend will trigger a textbook wage-price spiral. But wouldn’t it be nice if recent real wage growth turned out to be justified by a rebalancing of financial returns and the long-awaited return of positive productivity growth? With a new year comes a new hope.
Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK treasury minister, is a member of the Pan-European Commission on Health and Sustainable Development.
This commentary was published with the permission of Project Syndicate — The Inflation Challenge in 2024