Jerome Powell, chair of the US Federal Reserve.

In January, new UK Prime Minister Rishi Sunak made halving inflation of 10.1 per cent his “top priority”. Come year end, the UK economy is floundering, government debt needs tackling, asylum seekers and events in the Middle East are roiling politics, sacked Home Secretary Suella Braverman called Sunak “weak” and much else in a three-page attack, a pandemic inquiry heard evidence that Sunak’s preference was to “just let people die”, byelection losses have shocked the Conservatives, and polling points to a coming electoral thrashing.

But Sunak has achieved his foremost goal. Inflation slowed to 4.6 per cent in the 12 months to October after 14 rate increases by the Bank of England.

Curtailing pandemic inflation is happening elsewhere too – though less so in Australia where inflation has only slowed to 5.4 per cent from a 22-year high of 7.8 per cent in 2022. Eurozone inflation has plunged to 2.9 per cent from a record high of 10.6 per cent. US consumer inflation has dived to 3.2 per cent from a 40-year high of 9.1 per cent in 2022.

Economists hail that Federal Reserve chair Jerome Powell is achieving ‘immaculate disinflation’ – the term a JPMorgan economist conjured in March last year to ridicule the Fed’s rosy forecasts on inflation and unemployment. As hopes solidify about a ‘soft landing’, investors have wound back expectations of more rate increases.

But investors might have become too optimistic. Interest rates are reaching levels where they are hampering economies and the domestic inflationary forces still swirling could prove tougher to quell than the price increases caused by global shocks.

Inflation reached double digits in 2022 because the pandemic and Russia’s invasion of Ukraine disrupted supply as policymakers used monetary and fiscal policies to stoke demand. On the supply side, the pandemic shut factories, lockdown demand for online stuff led to chip shortages, while the war in Ukraine boosted energy and food prices. On the demand side, central banks cut interest rates to historic lows and printed money to fund massive fiscal stimulus.

Many of these supply disruptions are resolved. Factories have reopened. The chips scarcity is overcome. The West is sourcing energy away from Russia and oil has declined about 33 per cent from its 2022 high. Thus ‘headline’ inflation rates are dropping.

The problem for the fight to reduce inflation to central-bank targets of around 2 per cent is that aggregate demand is still bloated. Only in recent months have cash rates turned positive in real terms – and not yet in Australia (1.05 percentage points to the negative). So monetary policy is not tight, even if indebted populations are more rate sensitive. On the fiscal side, most governments (Canberra excepted but not the states) are injecting stimulus. Washington’s budget shortfall, for instance, is heading towards 7 per cent of GDP for fiscal 2023.

The energy transition is another source of inflation. Steps to combat climate change entail much investment that, to ensure a fair return, leads to higher power prices. Another cause of ‘greenflation’ is that the supply of fossil fuels is falling before demand has dropped.

The worry is that people, seeing the high cost of airfares, electricity, groceries, health services, housing, petrol and renting, have increased their inflation expectations – Americans in November said they expected prices to rise 4.5 per cent over the next 12 months, an eight-month high, and for costs to increase 3.2 per cent over the next five to 10 years, the highest since 2011.

Given growing views that inflation is entrenched, people are pushing for wage rises to compensate. Low unemployment is helping them succeed. Australian wages, for instance, jumped 1.3 per cent in the September quarter, the biggest increase in the wage-price index’s 26-year history and on the “high side”, according to Reserve Bank of Australia Governor Michele Bullock. US average hourly earnings gained 4.1 per cent in the year to October. The wages-prices spiral central banks dread is forming.

These factors explain why core inflation exceeds headline rates in key countries – but not Australia where the ‘trimmed mean’ rate is 5.2 per cent. Core inflation is running at 4.2 per cent in the eurozone, 5.7 per cent in the UK, and 4.0 per cent in the US.

Those picturing a prompt and costless victory over inflation will be sobered by an IMF paper released in September titled One hundred inflation shocks: Seven stylised facts. This paper looked at more than 100 episodes of inflation in 56 countries since the 1970s. It found that in only 60 per cent of cases was inflation tamed within five years, and that even in these successful cases inflation lingered for three years on average.

“Most unresolved episodes involved ‘premature celebrations’ where inflation declined initially, only to plateau at an elevated level or re-accelerate,” the authors said. “Successful disinflations were associated with short-term output losses.”

The first quote describes where we are today. The second hints to where today’s inflationary shock is headed. The eurozone and UK economies have stalled. Japan’s economy is shrinking. China’s economy is troubled. The global economy is slowing to levels considered recessionary. The US economy is cooling. Bloomberg reports that executives at the country’s biggest retailers including Home Depot, Macy’s, Target and Walmart say consumers are pulling back. In Australia, only immigration of about 500,000 this year is holding up the economy – GDP per capita is declining.

Central banks are getting the slowdown they are seeking to tame inflation. Circumstances, economic theory and history say these slowdown will need to turn into recessions to reduce inflation to within targets.

To be sure, the US could escape a downturn in 2024, or at least it’s the economy most likely to. That might only mean, however, trouble for the US the following year. A wider war in the Middle East, still considered possible, would make this analysis moot while validating its thrust. Maybe there could be something novel about economies today whereby inflation is conquered but the jobless rate stays low during a downturn.

But probably not. It’s worth noting the Fed has never managed to lop 4 percentage points off inflation without triggering a recession. Look at the political, economic and social damage wrought by reducing UK inflation by 5.5 percentage points. That damage would rise exponentially if inflation more than halved again as the BoE is required to do.

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