Stagflation Approaching? Inflation, yes. Stagnant growth, not so much

The emergence of a new variant of the coronavirus has raised fears that the US economy will suffer a double whammy with slowing growth and still high inflation, as supply chains falter, local governments contemplate new restrictions and consumers assess the health risks of any activity, from dining out and traveling to returning to work.

But economists so far see the risk of “stagflation” – that toxic mix of weak growth and strong inflation so feared by monetary leaders – only half. Prices are rising, more in the United States than elsewhere, and the pace has turned out to be more persistent than policymakers anticipated.

However, growth is far from stagnating and looks set to continue next year at an above-average rate that could bring the United States to full employment in a matter of months. Some analysts have moderated their growth forecasts for US gross domestic product due to the new variant.

But those revisions have been modest, and high-frequency data on U.S. air travel and metrics like restaurant visits and credit card spending so far show no apparent change in recent weeks, as case counts were increasing and, more recently, the omicron strain was identified.

“We are not going to see stagflation. We are going to see an inflationary rebound, ”as strong growth continues and the pace of rising prices has already prompted the Federal Reserve to reorient its monetary policy toward containing inflation, said Glenn Hubbard, Chairman of the Board of Advisors. Economics of former President George Bush and current professor of economics at Columbia University.

A Reuters poll of economists showed an average growth forecast of 3.9% for the United States in 2022, unchanged from November and roughly double the underlying trend growth rate estimated by the Federal Reserve and many private analysts. Policy makers at the Federal Reserve will release their own forecasts next week at a meeting where the most urgent preparations are expected to begin to ensure inflation remains under control.

Such forecasts will likely describe an economy close to full employment next year and one that will continue to grow faster than usual before the pandemic. The unemployment rate for November, 4.2%, is already well below the 4.8% level predicted by those responsible for the Federal Reserve in September, and close to the 4% rate considered sustainable in the long term.

Economy “booming”

Policymakers will also take into account stronger-than-anticipated inflation, as faster rate hikes are likely to be envisioned and plans to end their ongoing bond purchases in March, rather than in June.

It is still too early to understand how the omicron variant will behave and how people will behave when interacting with it. If it turns out that it spreads faster, evades vaccines, and is as deadly as the delta variant, it could trigger another wave of restrictions in some countries and factory or travel closures in others, with potentially detrimental results for growth and economy. global employment.

“It is not possible for countries to carry out again the great monetary policy impulse, the great fiscal policy impulse, that they were able to do these last two years. It cannot be repeated again, ”International Monetary Fund chief economist Gita Gopinath said at an event in Geneva on Thursday. If the omicron variant causes a new serious economic shock, “we will run the real risk of something that we have avoided so far, which is the concern about stagflation.”

But so far markets, analysts and economic data are not reflecting that kind of worst-case result. The latest variant was first identified in early November. Since then, the weekly number of travelers cleared on U.S. flights by the Transportation Security Administration has remained roughly the same or slightly higher compared to 2019, as it did in early fall.

In-person restaurant reservations have also held steady, according to data from the OpenTable reservation site. A recent study by the San Francisco Federal Reserve pointed out what has become a basic hope among monetary leaders: that American businesses and consumers, between the protection offered by vaccines and behavioral changes, will continue to work around to the virus.

“Local economic activity … was closely related to local COVID-19 conditions last year, but gradually declined as the pandemic progressed,” the researchers wrote, and the recent wave of the delta strain only caused a moderate drop in economic activity compared to the first months of the health crisis.

“It may not seem like it, given the high inflationary environment, renewed concern about COVID, and increased market volatility, but the economy is booming,” Oxford Economics US Chief Economist Gregory Daco wrote this week. .

Oxford’s recovery tracker, an index of combined health, economics and finance data, plunged in late November, but the decline was steepest among financial indicators after markets took a brief hit after March Day. Thanksgiving for the news of the omicron strain.

Demand and employment indicators remained strong, and Daco has so far responded to the omicron news with a slight downgrade of its 2022 GDP growth outlook, to 4.4% from 4.5%. Goldman Sachs economists, who pose omicron scenarios ranging from a worst-case scenario for the pandemic to rebound to a more positive outcome in which the variant causes a less serious illness, said they expected the final blow to GDP to be modest, and lowered their forecast for 2022 to 3.8% from 4.2%.

“Government monetary policy in the United States has become much less sensitive to the spread of the virus since vaccination rates increased this spring,” Goldman economists wrote, noting that its internal index of government restrictions to the coronavirus barely moved during the wave of infections of the delta variant during the summer.

Furthermore, “consumer spending and job growth have become much less sensitive to the local spread of the virus … probably due to lower risk aversion from COVID in the United States.”

This will leave the Fed focused on inflation even as it watches the course of the virus, and on that front the new variant may, if anything, anchor the central bank’s plans, the Goldman team wrote.

“We see that the risks in the medium and long term are mainly inflationary due to the possible delays in the normalization of the supply chain and the decrease in the shortage of workers,” Goldman wrote, with a probable rate hike in the middle of the year. .