For decades the conventional wisdom in macroeconomics has been that, beyond a certain point, low unemployment would trigger rising inflation. Next week’s numbers, however, will show that this isn’t true – at least not yet.
In the US, official figures are likely to show that consumer price inflation fell last month to around 1.7 per cent, its lowest rate since June 2017. That’s despite the fact that the official unemployment rate is near a 50-year low. And in the UK, consumer price inflation should be a mere 2.2 per cent despite the unemployment rate being at a 45-year low.
Why, then, isn’t low unemployment triggering rising inflation?
One answer is that unemployment in both countries isn’t as low as official figures suggest. In the UK, there are 1.9m people out of the labourforce who’d like a job – more than there are officially unemployed. And in the US, a wider measure of joblessness that includes those out of the labourforce who want a job and part-time workers who want full-time work is only at its 1999 level. Also, official figures show that capacity utilisation in US industry is only at its 2014 levels, suggesting there’s plenty of spare capacity in the economy.
Another reason, suggested by the Bank of England’s Andrew Haldane, is that the labour market is now more fragmented and trade unions are weaker, so that workers cannot parlay a tight labour market into higher wages as easily as they could in the past.
Yet another possibility is that we’ve fallen into a benign self-perpetuating equilibrium. Low inflation causes people to expect further low inflation and these expectations are self-fulfilling: if workers expect low inflation they’ll not demand much higher pay; and if companies expect their rivals to hold prices down they will too.
Also, inflation is increasingly set by global forces. Weakness in the eurozone and Chinese economies – purchasing managers in the latter last week reported falling output – are depressing inflation in the UK and US.
One channel through which they do so is simply commodity prices: the S&P GSCI, a popular index of commodity prices, has fallen 15 per cent since October 2018.
A second channel is the exchange rate. The strength of the US economy relative to the eurozone’s has pushed up the US dollar, making imports generally cheaper. Latest figures show that import prices have fallen in the past 12 months.
None of these considerations mean that inflation will stay low forever. But they are consistent with the Big Fact – that consumer price inflation in both the US and UK has been astonishingly stable for years. The idea that inflation will soar without the keen vigilance of central banks is a relic of the 1970s. Even if inflation does rise, it will do so slowly.
And this has pleasant implications for equity investors, although not cash savers. It means that the Fed and Bank of England can afford to err on the side of holding interest rates down. Even if they are wrong to do so – which is far from obvious now – the slowness of inflation to rise means it should be easy to correct their mistake.
