Your complete guide to inflation outlook in 2021 (Part 3)
Your complete guide to inflation outlook in 2021 (Part 3)
What could keep inflation low in 2021? Slow vaccine distribution; high unemployment; weak consumer spending; zombie companies muting real economic growth; too much government debt...
In Part 2, we provided an overview of the arguments for higher inflation in 2021: too much demand met by too little supply; surging commodity prices; supply chain constraints; dollar depreciation; money printing; the new monetary policy regime switch to average inflation targeting.
We did not mean to scare you, and in fact we think it’s much more likely to see weak inflation in 2021, and here are the main factors keeping inflation low.
What could keep inflation low in 2021?
1. Slow vaccine distribution
It is unlikely that we will put the virus completely behind us anytime soon, partly because of the slow vaccination speed. Bloomberg has a “Covid-19 Vaccine Tracker” that tells us the current pace and completed cases of vaccinations. Vaccinations in the U.S. began 12/14/2020 with healthcare workers, and so far 6.25 million doses have been given. The pace is around 1 million doses given per week, which means it will take 10 years to reach herd immunity in the U.S. assuming a herd immunity threshold at 80%.
The virus itself is what will continue to cause high unemployment and shutdown of the service industry, and as you can see it is not guaranteed the vaccines will effectively mitigate a more aggressive spread of the virus in 2021. This could continue to have a depressing effect on the U.S. economy, reducing the chance of higher inflation.
2. Persistently high unemployment and weak labor market
Even if we successfully reach herd immunity by this summer, you cannot bring back the jobs lost permanently. 17% of all restaurants and bars (more than 110,000 establishments) have closed permanently during Covid; around 2 million restaurant jobs have been permanently destroyed.
The key statistics that we’ve iterated many times is that November still had 10 million fewer jobs than in February, and 1/3 of all job losses up to this point (at least 3.5 million jobs) are not going to come back in 2021.
The Phillips Curve shows an inverse relationship between inflation and unemployment – that lower unemployment rate would signal an overheating economy and push up inflation. However, unemployment continues to remain persistently high, around 6.7% in December. The Fed only expects the unemployment rate to decline back to less than 3.5% by 2023.
It will take several years before we return to pre-pandemic levels of employment. We’re still far from an overheating economy. See below for a plot of jobless claims that remain high above pre-pandemic levels:
Former NY Fed President Bill Dudely also noted in his recent podcast with Bloomberg that the “headline” unemployment figure likely understates true levels of unemployment. The reported rate, known as U3, only counts individuals who have been recently laid off and are actively searching for a new opportunity. Moreover, any individual who has become discouraged by the pandemic labor market and ceased looking for a new job will not be included in the percentage. It is likely the total number of Americans without jobs is underestimated, which further dampens the likelihood of any demand-pull inflation effects.
With a high number of people out of work, there is less potential for aggregate demand in the U.S. economy to rise and push up the price level for various goods and services.
3. Suppressed consumer spending
Even if the virus resides and unemployment drops to normal levels by this summer, the financial burden of the virus on households might still cause a lagged drawback in aggregate demand for goods and services. It’s not that consumers don’t have money to spend; it’s just the demand for services won’t pick back up anytime soon. For instance, air travel in the U.S. is now ~60% lower than a year ago, and it will likely not rebound back to the pre-pandemic level until 2022, so ticket prices will likely remain low.
In November, consumer spending had shown its first month-over-month decline of -0.4% since April. (See here for the November report from the U.S. Bureau of Economic Analysis.)
Generally, spending patterns could suffer if consumers find themselves struggling with employment and debt, like mortgages and credit card loans. On the other hand, spending could improve with support to households from the newly passed fiscal stimulus in December.
One common worry is that the American consumers will be inclined to spend less and save more after returning to normalcy, which is a hypothesis recently rejected by Goldman Sachs chief economist Jan Hatzius. It is more likely that spending will eventually return to the pre-pandemic level; it’s just it won’t occur until at least late 2021.
4. Zombie companies depress real economic growth
Persistently low interest rates could support “zombie corporations”, keeping real economic growth muted. The Fed keeping rates near zero allows access to cheap debt that many already indebted and low growth companies take advantage of, getting the name “zombie” from their tendency to be seemingly insolvent but barely survive.
Companies like these soaking up assets could ultimately drag on real economic growth and rising price levels. America’s zombie companies are racking up $2 trillion of debt, and an increasing number of firms have become “zombified” since the onset of the pandemic. With low interest rates projected until 2023, this situation could continue to worsen.
5. Supply chain constraints won’t push up too much inflation
In Part 2, we explained that inefficiency in global supply chains and rising commodities prices could both push up import prices and thus cause inflation in the U.S. However, one important statistic is that global trade volumes are now back at pre-pandemic level, which makes it much less valid to worry about higher inflation caused by supply chain weaknesses or declining supply of goods.
Apollo chief economist Torsten Slok said in a recent email that the cost of transporting a container between countries has increased significantly in recent months, driven partly by strong growth in China, and high demand for goods in Europe and the U.S. However, the transportation and logistics costs are less than 10% of sales depending on the industry sector, so the impact on U.S. inflation is minimal. The U.S. economy is also much less dependent on trade, with imports only making up 15% of GDP (as opposed to 40% in several European economies).
Therefore, though many worry that supply chain constraints could push up prices for certain goods, they will not be a major source of broad-based inflation for the domestic U.S. economy.
6. Too much government debt
A large amount of government debt could have downward pressure on real economic growth and inflation, as exemplified by Japan. This is again another huge topic that we will discuss some other time.
To be continued…
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