First appearance at Policy Center for the New South (November 2, 2021)
The scarcity of inputs and goods has been felt all over the world due to disruptions in global value chains since the start of the pandemic. Factory closures in China in early 2020, closures in many countries and, subsequently, congestion of logistics networks for transporting goods, capacity constraints in the face of sudden surges in demand and shortages of labor force, have combined to negatively affect the availability of inputs and outputs around the world.
Higher freight prices and unprecedented delays in parcel delivery times have become widespread. Figure 1 — from Moody’s Credit outlook Oct 18 report – shows delivery times from global manufacturing suppliers as measured by the Purchasing Managers Index (PMI) and container shipping rates as measured by the Charter Rate Index by Harper Petersen. The PMI data is inverted by subtracting the data from 100; therefore, increasing (decreasing) PMI data indicates faster (slower) delivery times. Container shipping rates are monthly averages of weekly data. Global supply chain disruptions have reached all-time highs, and shipping and logistics constraints are yet to abate.
These disturbances have consequences for inflation and GDP. In the United States, the Federal Reserve’s (Fed) ‘beige book’ published two weeks ago indicated a slowdown in the pace of GDP growth in the third quarter of 2021 due to disruptions in supply chains, shortages of labor force and uncertainties around the delta. variant of COVID-19.
In the meantime, inflation has increased. The consumer price index that serves as the main benchmark for US monetary policy, published on October 29, 2021, has risen 4.4% over the past twelve months, above the rate that serves as a benchmark as the average pursued by the Fed.
Rising inflation is a global phenomenon, although it has different intensities and multiple determinants. Several emerging and developing countries have faced rising commodity prices without simultaneous capital inflows and nominal exchange rate appreciation, resulting in higher domestic prices for consumer baskets.
JP Morgan estimated global consumer prices to accelerate to almost an annual rate of 5% in the third quarter of the year, negatively impacting household purchasing power and spending on consumer goods, before falling. moderate this quarter (Figure 2). Supply disruptions have been a major factor, especially in advanced economies. However, the scarcity of imported inputs has also had an impact on manufacturing activity in emerging countries and developing economies: for example, Brazilian automakers have interrupted their production chains due to the lack of semiconductors.
It is essential to understand that delivery delays since 2020 have two aspects: supply and demand. On the supply side, the complexity, density and geographical distribution of value chains make final delivery very vulnerable to blockages at any link.
On the demand side, there have been significant changes in composition and volume since 2020. The substitution of consumption of contact-intensive services with home electronics has led to an explosion in demand for semiconductors, for example. At the same time, especially in advanced countries, budget support plans have enabled families to maintain their disposable income during the pandemic. This happened to such an extent that in September, American consumers were able to use the accumulated savings to continue shopping at a rate greater than the increase in their personal income.
A mismatch between demand and supply can also be found in energy price shocks (Figure 3), showing how bumpy the road to decarbonization will be. Low gas stocks in Europe, restrictions on the availability of coal in China and India and limits on shale oil production capacity in the United States have all been faced as alternative renewable energy supply is still insufficient.
In China, energy shortages have led to temporary shutdowns of industrial production in some regions, further disrupting value chains, with global repercussions. It has become clearer than ever that it is necessary to strengthen the supply of renewable energy to avoid the tension of supply over demand for energy and to make the system less vulnerable to shocks resulting from accidents and routine maintenance problems and, this year, weak winds as in Europe, droughts that have jeopardized hydroelectric production in Brazil and floods in Asia hampering the delivery of coal.
The functioning of supply chains in the United States has also been affected by an unexpected contraction in the workforce due to accelerating retirements caused by the pandemic. According to Miguel Faria e Castro of the Federal Reserve of St. Louis, more than half of the 5.25 million people who left the country’s labor force from the start of the pandemic until the second quarter of 2021 corresponded to more than 3 million surpluses. retreats during COVID-19 (Figure 4). The author puts forward two major reasons: increased risks to the health of the elderly and / or due to the enrichment resulting from the appreciation of financial assets which reflected monetary policy during the pandemic.
The pace of economic recovery in the United States and attempts to rebuild value chains with the reopening of the economy have faced labor shortages, temporary or otherwise. The fact is that nominal wage increases have increased (Chart 5).
The inflationary scenario has started to change with the prospect that value chain disruptions and supply constraints will take some time to correct, at least until the first half of 2022. In the United States, the rate differential yield between nominal 5-year rates Treasury bills and those protected against inflation over the same period have fallen in recent weeks from levels of around 2.5% to almost 3% per year (graph 6 ). While this in part reflects a greater perception of the risks resulting from errors in the inflation forecasts themselves, the point is, it suggests that investors expect higher inflation to persist.
The “showdown” between hawks and doves over how the Fed should proceed with monetary policy will become more dramatic. Inflation is always a question of the mismatch between supply and demand, whatever the origin of the shocks. However, as Randal K. Quarles, one of the members of the Fed’s Board of Governors, put it at an event two weeks ago:
“The fundamental dilemma we currently face at the Fed is this: demand, boosted by unprecedented fiscal stimulus, has outpaced temporarily disrupted supply, resulting in high inflation. But the fundamental productive capacity of our economy as it existed just before COVID – and, therefore, the ability to meet that demand without inflation – remains largely as it was, and the factors disrupting it appear to be transient. Considered only from this angle, it would be premature to restrict demand today, to adapt it to a temporarily interrupted supply. Given the lags with which monetary policy operates, we could easily see that demand slows as supply increases, causing us to underestimate our inflation target and, in the worst case, we could reduce incentives to return to supply, leading to a prolonged period of sluggish activity and unnecessarily low employment. (…) I am one of those who see a good chance that inflation will stay above 2% next year, but I am not quite ready to conclude that this “transitional” period is already “too much”. long “. (…) Therefore, we will remain results-based, waiting to see further improvements in employment and the development of inflationary pressures in the months to come.. “
The Fed’s “soap opera plot”, therefore, pits those who favor a “wait-and-see attitude” – moving to cutback this year and likely small hikes at the end of next year – and those who think the Fed is already behind on policy reorientation. I must admit leaning in favor of giving more time to see if the constraints in the supply chain dissipate, among other reasons, as inflation rates just above 2% per year in 2022 are in line with the new framework. the Fed’s average inflation targeting.
However, it should also be borne in mind that some sort of financial adjustment is inevitable as interest rates rise. As we approached earlier this year, the “great US balance sheet economy” has been on a growth path heavily dependent on continued low real interest rates, as well as tight price-to-earnings ratios of equities and high corporate debt. Periodic episodes of downward adjustment in asset prices have been offset by lax monetary policies. And even if gradual wait-and-see policy tightening turns out to be the appropriate response, lax monetary policy as a means of avoiding asset price adjustments seems temporarily exhausted at this point.
There is another polarized plot between those who attribute partial responsibility for value chain disruptions to governments and those who specifically point to such disruptions as an argument for less globalization. But that will be the subject of another day.
Washington, DC-based Otaviano Canuto is Senior Fellow at Policy Center for the New South, Non-Resident Senior Fellow at Brookings Institution, Lecturer in International Affairs at Elliott School of International Affairs – George Washington University, Affiliate Professor at UM6P, and director at the Center for Macroeconomics and Development. He is a former vice-president and former executive director of the World Bank, former executive director of the International Monetary Fund and former vice-president of the Inter-American Development Bank. He is also a former Deputy Minister of International Affairs at the Brazilian Ministry of Finance and a former Professor of Economics at the University of São Paulo and the University of Campinas, Brazil.