November 2023


Inflation: Has it finally broken lower?

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After two years of unsettling and persistent global inflation, investors and policy makers alike are asking when it will finally let up.

Although the worst appears to be behind us, Alberto Cavallo, professor at Harvard Business School, co-founder of PriceStats® and State Street Associates academic partner, cautioned that we are not completely out of the woods on inflation yet.

“Since mid-2022, the annual inflation rate on a global scale has fallen and it does seem to be stabilizing now. But it is stabilizing at a level that is higher than before [the COVID-19 pandemic],” he said.

As part of his ongoing analysis of the impact of inflation on global economies, Cavallo used the structural-break method, as well as data from PriceStats’ real-time inflation series, to find inflation turning points and trends.

State Street’s PriceStats tracks inflation data from the United States and 24 other countries, using web-scraping technology to compile prices for millions of consumer products sold by hundreds of online retailers around the world, and produces aggregate inflation series from these data points.

Below are key highlights of his research:

Disinflation without recession
Though global inflation is now stabilizing at 4 percent, down from its mid-2022 peak of 7 percent, levels are still well above average in many countries, according to Cavallo.

Still, he said, we have entered a disinflation period, or a stretch of slower inflation. In the US, disinflation has been evident for some time, and that has stoked fears of a recession. However, Cavallo believes a recession can be avoided as long as the normalization of supply chains continues.

“This improvement in supply is an important driver of the recent disinflation process. It’s not magic; it’s not immaculate in some way. It’s just simply supply and demand,” he said.

Inflation base effects
When identifying inflation trends, Cavallo noted it is better to focus on the price index than to rely on annual or monthly inflation rates, which are based on data from weeks or months earlier. Base effects – the impact of the previous year’s price growth on current estimates – is behind some of the moderation we are currently experiencing and will impact levels going forward, he said.

“If this continues to be the case, it will have an impact on the annual inflation rate. We will see those numbers go up, and many people are going to get concerned. But I want to emphasize that’s not because of a change in trend right now, but rather by the base effects and what happened 12 months ago,” he said.

Inflation turning points
The price index is also useful for detecting turning points in inflation. For example, through an analysis of disaggregated data of key economic sectors, Cavallo was able to detect a turning point in headline inflation as early as September 2022, and November 2022 for core inflation.

Of the 25 countries analyzed, China was actually the first country where an inflation turning point was detected, followed by Brazil and the US. Europe turned later, but nearly all countries had turning points in the past year, according to his research.

Though the latest official US inflation numbers may raise concern about another turning point soon, Cavallo said that based on real-time data of indicators across economic sectors, there is currently no evidence of another inflationary turning point yet, adding that any uptick we are currently seeing may be attributed to higher energy prices.

Inflationary shocks
Russia’s war against Ukraine built up inflationary pressures across the globe, pushing up consumer prices and creating inflationary shocks, a sudden rise in commodity prices that ultimately led to a loss of consumer purchasing power.

As companies began to frequently adjust prices to account for these shocks, it resulted in higher costs being passed through to consumers. That pass-through rate, according to Cavallo, has remained quite high ever since, because companies have less incentive to pass through cost decreases.

“If there is positive inflation and you know that your costs are going to continue to go up, then there is no need to drop your prices today. You can wait until inflation takes your prices to their optimal level,” he said.

The attempt by companies to continue to recover margins explains some of the persistence in inflation rates going forward, said Cavallo.

Looking ahead
Undoubtedly, the pandemic led to historic and long-lasting inflation and supply disruptions. Though inflation clouds still loom, Cavallo sees clearer skies ahead.

“I’ve seen many things brought about by COVID eventually returning back to normal. So, I’m overall optimistic that we’ll get there finally,” he said. “COVID was a different crisis because of the impact on supply. So, to the extent that supply can recover, we may not need to see a recession and we can bring [inflation] down.”

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