The transitory inflation conjecture gains even more data credence

Yesterday (November 30, 2022), the Australian Bureau of Statistics released the latest – Monthly Consumer Price Index Indicator – which is a new data series that the ABS has introduced to augment the quarterly CPI index release. Regular readers will know that I have considered this period of inflation to be transitory, which means that it is likely to dissipate rather quickly once the driving factors abate. It doesn’t mean that those driving factors are necessarily short-term in horizon. They might persist. But the important point is that second-round propagating mechanisms such as the wage-price distributional battle over markups are not present as they were in the 1970s, which is why that episode had a life of its own once the initial oil price supply shock adjustment was made. The other significant aspect of my assessment is that this current inflationary period does not indicate excessive fiscal support nor does it justify central banks hiking interest rates. The drivers at present are originating from the supply-side (pandemic, long Covid, OPEC+ and the Ukraine situation) and are not sensitive to any degree to interest rate changes. I have received a lot of criticism for holding this view. The Modern Monetary Theory (MMT) is dead crowd constantly E-mail me or try to push acrid comments on this blog telling me to get another life or end my existing one. The problem for them is that the latest data from around the world is telling me that this period of inflation is peaking as the supply drivers start to wane.

Eurostat data shows inflation has peaked in Europe

The latest flash estimate data from Eurostat – Euro area annual inflation down to 10.0% (released November 30 2022) – shows that:

1. “Euro area annual inflation is expected to be 10.0% in November 2022, down from 10.6% in October”.

2. “Looking at the main components of euro area inflation, energy is expected to have the highest annual rate in November (34.9%, compared with 41.5% in October), followed by food, alcohol & tobacco (13.6%, compared with 13.1% in October), non-energy industrial goods (6.1%, stable compared with October) and services (4.2%, compared with 4.3% in October).”

3. Belgium 10.5 per cent (down from 13.1 per cent in October); Germany 11.3 down from 11.6; Greece 9 down from 9.5; Spain 6.6 down from 7.3; Italy 12.5 down from 12.6; France constant at 7.1; Netherlands 11.2 down from 16.8; Austria 11.1 down from 11.5 etc.

It certainly looks as though the supply drivers are abating somewhat.

Australian inflation also seems to have peaked

I say peaked cautiously because the current flooding in NSW, which is affecting food production may still cause further price pressures in the coming months before a recovery is possible.

But that won’t alter the assessment that this is a supply-side phenomenon and interest rate changes will do nothing to make the lettuces and carrots grow back more quickly.

The latest data from the ABS shows that the All Groups CPI increased by 6.9 per cent over the 12 months to October 2022, after recording a 7.3 per cent increase over the 12 months to September 2022.

However, the monthly CPI inflation rate for October 2022 came in at 0.17 per cent down from 0.61 per cent and the lowest reading since April 2022 and then since February 2021.

The following graphs shows the annual and monthly CPI inflation rates (respectively).

It is clear that the latest monthly estimate is a break on the previous several months, notwithstanding the recent outlier in April 2022.

Annual CPI inflation rate

Monthly CPI inflation rate

When we talk about inflation there are various ways we can express the situation.

1. We can talk about annual inflation – over the last 12 months – and that figure is 6.9 per cent and falling.

2. We can talk about the annualised quarterly rate – given the CPI in Australia has traditionally been published at this frequency – so we would multiply the quarterly rate by 4. That figure in October 2022 would be 4.21 per cent down from 5.64 per cent in September.

3. We can talk about the annualised monthly rate – so we would multiply the current monthly rate by 12. That figure is 2.1 per cent in October 2022, down from 7.34 per cent.

The interpretation of which is a better indicator of the current situation is influenced by the trend of the time series.

It is clear the trend is down and the latest monthly estimate is probably representative of where the series is heading.

Which means that Australia’s inflation problem is passing quickly.

Has this been the work of the RBA interest rate hikes?

The answer is a categorical No!

We can get to that conclusion by examining the components that make up the All Groups CPI outcome.

The ABS press release (November 30, 2022) – The monthly CPI indicator rose 6.9 per cent in the 12 months to October 2022 – noted that:

Each year, the ABS updates the expenditure weights applied to the CPI basket … This is important to ensure the CPI basket remains up to date and representative of current spending by households … Typically, annual updates to the weights have limited impact on the overall CPI. This year, however, the significant changes in spending patterns over 2021 and 2022 meant that the reweight had a larger impact on the CPI than usual. The annual movement of the monthly CPI indicator in October, using the previous weights, would have been 7.1 per cent compared to 6.9 per cent using the new weights.

So we always have to appreciate that these data are statistical artefacts and the if there are changes in the underlying methodology then the estimates change even though nothing substantive has changed on the ground.

When we dig into the components of the All Groups CPI result we find that:

1. Automotive fuel prices rise from an annual 10.1 per cent in September to 11.8 per cent in October. This was entirely due to the federal government decision to end the subsidy being provided by the temporary suspension of the fuel excise tax.

But the underlying trend is down as world oil prices fall.

2. Fruit and vegetable prices which rose quickly due to floods and transport costs fell from an annual figure of 17.4 per cent in September to 9.4 per cent in October.

This is an example of how quickly the situation can change when the temporary supply disruptions ease.

3. Building construction costs rose by 0.4 per cent on top of the 20 per cent in September as a result of labour and material shortages primarily.

The timber shortages go back to the huge bush fires just before the pandemic and also to disruptions arising from the Ukraine situation.

There are also other material shortages due to Covid disruptions in China and elsewhere.

4. Housing overall inflated by 10.5 per cent over the year to October 2022, up from 10.3 per cent in September. So the interest rate increases are doing nothing to quell this sector.

The following graph shows the annual rates for the major All Groups CPI components.

As you can see, the trend is down in most of the component groups.

And what about the impact of fiscal policy?

The purpose of fiscal policy, among other things, is to ensure spending is sufficient to create enough demand in the economy that is consistent with full employment.

At present, Australia’s unemployment rate is relatively low but we would not yet say we are at full employment because the total underutilisation rate is above 9.4 per cent (the sum of the unemployment and underemployment rates).

The main reason the unemployment rate is so low is because the external borders were shut during the early days of the pandemic and migration has not yet fully recovered.

Once the working age population returns to its previous growth rates then the unemployment rate will rise a bit unless total demand increases.

But we can make some assessment of whether fiscal policy has ‘over stimulated’ the economy by looking at the wage situation.

The mainstream view of the link between inflation and unemployment is that when the unemployment rate reaches the so-called Non-Accelerating-Inflation-Rate-of-Unemployment (NAIRU) then the wages pressure that builds at that rate is likely to be consistent with productivity growth and so unit costs are constant and inflation is stable.

The mainstream narrative then would say that fiscal policy is over-stimulating the economy if the unemployment falls below the unobserved NAIRU.

While the NAIRU is unobserved, the manifestation of the over-stimulation according to this story would be excessive wages pressure outstripping productivity growth and driving unit costs up which are then passed on as higher prices.

So, even within that narrative space, if wages growth is weak and the wage share is falling (which means that real wages are being outstripped by productivity growth) then it is difficult to say that the unemployment rate is ‘too low’ and below the NAIRU.

Of course, I don’t buy the NAIRU story at all.

But the fact that wages growth is low and certainly not driving this inflationary episode and that real unit labour costs are falling (evidenced by the wage share falling), tells me that fiscal policy is not over stimulating the demand side.

Unemployment is relatively low but not so low that inflation pressures are emanating from the labour market.

Conclusion

I stand by my earlier assessment in 2021 that this is a transitory inflation and as various driving factors abate, so will the inflation.

There is no structural propagation present.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.