he President of the Federal Reserve Bank of St. Louis, James Bullard, has predicted that disinflation, a decrease in the rate of inflation, will occur in 2023. In a presentation at an event hosted by the CFA Society St. Louis, Bullard cited several factors that may contribute to disinflation.
Economic Indicators Point to Disinflation
GDP growth in the third and fourth quarters of 2022 is estimated to have grown at an annual rate of 3.2% and above trend, respectively. This marks an improvement from the first half of the year, which saw puzzling readings in terms of GDP growth. While year-on-year growth is slowing, according to incoming data, the output gap remains positive. It appears that real GDP growth is slowing to be in a neighbourhood just below the potential growth rate of about 2% on a year-on-year basis after strong growth in 2021, according to Bullard.
The labour market also remains strong, with the number of job openings per unemployed worker at high levels and unemployment insurance claims remaining below pre-pandemic levels. In fact, the current labour market situation has been unprecedented in a historical perspective since the 1980s, with measures of labour demand significantly exceeding measures of labour supply, according to Bullard.
Inflation has declined recently, although it remains too high. The Federal Open Market Committee has a 2% inflation target specified in terms of headline personal consumption expenditures (PCE) inflation. Headline inflation has declined, but it can be inordinately influenced by fluctuations in energy and food prices. Measures of inflation that strip out volatile price movements, such as core PCE inflation and the Dallas Fed's trimmed mean inflation measure, have also declined, but by less than the headline measure. Inflation expectations have also returned to relatively low levels.
Policy Measures Contribute to Lower Inflation Expectations
According to standard macroeconomic theories, inflation expectations are a key determinant of actual inflation. The policy rate is getting closer to a level that may be considered sufficiently restrictive, and front-loaded Fed policy has helped lower market-based measures of inflation expectations to relatively low levels. According to Bullard, these factors may combine to make 2023 a disinflationary year.
Potential Impact of Disinflation on the Economy
One of the main considerations for central banks when setting interest rates is the rate of inflation. If inflation is high, central banks may increase interest rates in order to slow down the economy and bring inflation down to a more desirable level. Conversely, if inflation is low or declining, central banks may lower interest rates in order to stimulate economic growth.
In an economy with high inflation, disinflation could be seen as a positive development, as it indicates a slowing of price increases and can provide relief to consumers and businesses by reducing pressure on purchasing power, it may also lead to lower interest rates. Lower interest rates can make borrowing cheaper for individuals and businesses, which can stimulate economic activity and increase demand for goods and services. Lower interest rates can also be positive for stocks and other assets that tend to perform well in a low-interest-rate environment. However, it is important to consider the potential impact of disinflation on the overall economy and financial markets, as it may be accompanied by a slowdown in economic growth and negatively impact company profits and stock prices.
If disinflation is sustained over a period of time, it can eventually lead to a decrease in the general price level of goods and services, which is known as deflation. However, deflation if unlikely to become an issue over the short to medium-term.
While disinflation can be a positive development in some circumstances, it is important to ensure that it does not lead to deflation or a slowdown in economic growth.
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