What is the outlook for the American economy?
This morning, the Bureau of Labor Statistics (BLS) released its numbers for inflation in November. They showed inflation rising from October’s rate of 0.0% to a 0.1% increase in the Consumer Price Index (CPI). The inflation rate over the last 12 months fell too, from October’s reading of 3.2% to 3.1%.
Last month, I wrote that:
…the primary driver of our recent surge of inflation was the massive infusion of new money and credit created by the Federal Reserve to keep down the costs of Federal government borrowing during COVID-19. As that money and credit growth has slowed — indeed, the broad measure of money, M2, has actually declined in every single month since December last year — so has inflation…This shows, I think, that we can expect inflation to go on slowing for a little while just yet.
Today’s numbers confirm that. If the inflation rate — the change in the level of the CPI — continues to track changes in the growth rate of M2, I expect inflation to be back under the Federal Reserve’s target of 2.0% by about March or April next year.
There are two more things to note.
First, this slowing of the growth of money and credit — indeed, its outright decline in recent months — has meant that the price of credit has gone up. You will have seen this in increased mortgage rates and interest rates on credit cards, for example. This has squeezed consumer spending. In August 2022, I saw a squeeze on people’s real incomes from inflation as one step towards a recession. That hasn’t happened, but that, I think, is because savings piled up during COVID-19 have cushioned Americans from that. As these savings have been unwound, however, this cushion will go and people will feel the squeeze more acutely.
Second, this fall in the inflation rate will, at some point, prompt the Federal Reserve to cut the funds rate. This should bring down interest rates across the economy and ease the squeeze on American consumers. If I’m right and inflation is back at 2.0% in March or April next year, the Fed will be under pressure to cut pretty promptly, especially with an election coming up.
To some extent, then, I see the American economy going into the new year as a race between two factors: one is the squeeze on American’s spending which will drive economic activity down and the other is loosening credit conditions as inflation falls and the Fed cuts rates which will, in the short term at least, drive economic activity up. We will see in 2024.