With inflation hitting highs in more than 30 years, Goldman Sachs economists hope that the underlying imbalances between supply and demand will resolve themselves, leaving prices close to the Federal Reserve target. However, it is now clear that this process will take longer than initially expected and “excess inflation is likely to get worse before it gets better,” as Spencer Hill and David Mericle argue.
For both Goldman economists, the first and most important question for the price outlook in 2022 is whether the imbalances between supply and demand in the goods sector will moderate enough for prices to begin to normalize.
“We expect supply chain disruptions gradually overcome and that the demand for goods moderates as spending on services recovers and the maximum fiscal impulse disappears, “they explain in a report released this week.
As inventories rebuild, the goods sector should move from an unusual environment of scarcity to an environment of abundance in which competition will drive down high prices. This process will start andn the second semester of next year and it will run until 2023, they warn.
The second question is whether wage growth will cool now that unemployment benefits implemented to deal with the pandemic have expired. Over the past six months, labor shortages have driven wage growth at an annualized rate of 5-6% which, if sustained, would likely be incompatible with 2% inflation.
That is why Hill and Mericle hope that wage growth slows to just over 4% as the supply of labor returns, somewhat stronger than in the last cycle but consistent with the Fed’s inflation target.
The third key question is how hot the house prices. Rents have already skyrocketed and Goldman expects the job market recovery and spillover effects from the housing price boom to push the official housing measure above 4.5% by the end of 2022.
Inflationary pressure
The accelerated increase in wages and rents should provide a more persistent inflationary pressure in the coming years, keeping core inflation moderately above 2% this cycle, above the pace observed in the last cycle, and in line with the objective of the Federal Reserve under its new framework.
In this way, the prolonged imbalances between supply and demand, the strong growth of wages and the acceleration of rents will leave the underlying reading of the PCE (Personal Consumption Price Index) and, especially, the underlying CPI, quite high for much of the next year.
Nonetheless, Goldman’s economists believe that as supply-constrained categories shift from a transitory inflationary boost to a transitory deflationary drag, core PCE inflation, the Fed’s favorite measure of prices, will fall below the 4.4% by the end of 2021 to 2.3% by the end of 2022 and 2.1% by the end of 2023.
This will be the roadmap for the normalization of the supply chain, according to Goldman
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