What We're Reading:
What We're Reading:
Biden: Nuclear ‘Armageddon’ risk highest since ’62 crisis. President Joe Biden said the risk of nuclear “Armageddon” is at the highest level since the 1962 Cuban Missile Crisis, as Russian officials speak of the possibility of using tactical nuclear weapons after suffering massive setbacks in the eight-month invasion of Ukraine. (AP)
Zero-covid: How Xi's flagship policy is spoiling his party. In recent weeks, tens of millions of people have again been confined to their homes in lockdowns across 60 towns and cities and this is bringing political pressure on the man who has become the most powerful Chinese figure since the first Communist-era leader Mao Zedong. (BBC)
Germans using too much gas, could face emergency later authorities warn. The Federal Network Agency warned that Germany could be faced with gas shortages this winter if consumption is not reduced by at least 20%. Instead, use jumped 10% last week, alarming experts. (DW)
WTO slashes trade growth forecast as global picture ‘darkens’. Growth in global merchandise trade could shrink considerably in 2023, the World Trade Organization (WTO) has warned, as it slashes its growth forecasts in response to spiraling inflation and the uncertain impacts of Russia’s invasion of Ukraine. (Global Trade Review)
Can the political center return in Chile? Chileans of all walks of life had clamored for years for a new constitution, yet last month, voters changed their minds and took a 180-degree turn, rejecting the new document. (Brink News)
Food supply boost key to cooling inflation—DOF. Finance Secretary Benjamin E. Diokno said the government will ramp up its efforts to boost food supply either via local production or importation in order to temper the country’s accelerating inflation. (Business Mirror)
US trade deficit narrows in August on further imports drop. The U.S. trade gap declined for a fifth straight month in August as imports, including oil, fell further, according to official data released Wednesday. Exports edged down as well on decreases in industrial supplies and materials, the Commerce Department said. (IndustryWeek)
After a hot summer, hiring cools in September as employers add 263,000 jobs. The Labor Department reported Friday that U.S. employers added 263,000 jobs last month—a modest decrease from the 315,000 jobs in August. The unemployment rate dipped to 3.5%, matching a half-century low. (NPR)
FBX Index: Back to 2020 levels. In terms of capacity, the latest data covering the period until end-August shows that bottlenecks continue to improve in the liner shipping network. It is literally a matter of “glass half full or glass half empty.” (HSN)
Yemen: Strife-torn country once again at the mercy of regional foes Iran and Saudi Arabia. With the end of a truce on October 2, the Yemeni population is facing more hardship as the two warring factions, backed by Iran and Saudi Arabia respectively, pick up where they left off. (DW)
Biden has $52 billion for semiconductors. Today, work begins to spend that windfall. President Biden is heading to an IBM manufacturing plant in New York on Thursday to tout a new $20 billion investment the company is making in semiconductor research and development as well as other advanced technologies. (NPR)
Africa trade report: Many challenges, and few opportunities. Just as the continent seemed to be staging an economic recovery from the Covid-19 pandemic, a new shock in the shape of the Russian invasion of Ukraine is weighing on Africa’s prospects—although some bright spots remain. (Global Trade Review)
ISM: Manufacturing hangs on to growth despite sliding orders. Despite improving supply conditions for many parts, electrical and electronic components remain both in short supply and up in price. (IndustryWeek)
OPEC’s Massive Oil Cut Fuels Fear
Kendall Payton, editorial associate
The OPEC+ alliance announced a decision to cut 2 million barrels per day in oil production. Amidst the current global energy crisis, major oil cuts will likely cause gas and oil prices to soar again. “Oil prices on Friday were on track for their biggest weekly increase since March, as OPEC’s planned production cut heightened tension with the U.S. government over energy supplies heading into winter,” reads an article from Barron’s.
Though it is undetermined how high prices will increase, the White House administration plans to “deliver another 10 million barrels from the Strategic Petroleum Reserve to the market next month, continuing the historic releases the President ordered in March,” according to NPR.
The coalition of OPEC, Russia and allied producers announced oil cuts to start this November while meeting at the Vienna headquarters of the OPEC oil cartel—as the organization based their decision on global economic and oil market outlooks, per AP News. “Following a token trim last month, Wednesday’s decision is an abrupt turnaround from months of restoring deep cuts made during the depths of the pandemic,” the article reads. “As demand rebounded, global energy prices have swung wildly since Russia invaded Ukraine, helping fuel inflation that is squeezing economies worldwide.”
With the energy market already uncertain due to the Russian-Ukraine war, OPEC’s oil cuts can help Russia “weather a looming European ban on most of Moscow’s oil,” according to AP News. But Russia’s membership to OPEC+ raises a red flag of how the country may have influenced the major decision.
Some officials agree that OPEC’s decision was made in alignment with Russia. “Putin has been able to insert himself in what was a pretty strong relationship between the U.S. and Saudi Arabia,” Jim Krane, a fellow with the school's Baker Institute for Public Policy, told Axios.
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Inflation Changes Global Supply Chain Once Again
Jamilex Gotay, editorial associate
In just a few years, the global supply chain has gone through a rollercoaster of disruptions. When the pandemic began, consumer demand rose significantly. “There are customers who historically ordered just-in-time and switched to ordering in advance for their anticipated production demands,” explained Joseph Lange, CCE, ICCE, CCRA, senior credit manager at Brenntag North America, Inc. (Wauwatosa, WI). “Customers started placing orders from two to six months out and in some cases up to 12 months.”
But high inflation rates have lowered customer demand and changed buying patterns. “As of late, customers have taken on more inventory than their production demands, so they have enough inventory to last them for 3 to 6 months,” Lange said. Now, there’s no need for his customers to order more product.
“Unlike in late 2021, when retail execs on conference calls talked about import delays and marking up goods to pass along surging freight costs, they’re now talking about having too much inventory in warehouses and discounting goods to clear the excess,” reads an article from American Shipper.
But even though supply snags are showing signs of relief, global inflation is still scorching. Why? “One theory is that the supply chain was at least something of a red herring,” the article continues. “Another is that supply chain pressures are indeed easing, but they’re still way above pre-COVID levels. In other words, the supply chain crunch is not over yet, so the positive payoff for inflation is yet to come.”
Wage-Price Spiral Risks Appear Contained Despite High Inflation
John Bluedorn, IMF
Inflation in some economies is rising at the fastest pace in four decades, while tight labor markets have boosted pay gains. That has raised concerns that these conditions could become self-reinforcing and lead to a wage-price spiral—a prolonged loop in which inflation leads to higher wage growth, fueling even higher inflation.
An examination of recent wage dynamics and the prospect of such a wage-price spiral are the subjects of an analytical chapter of our latest World Economic Outlook, which finds that, on average, the risks of a spiral are limited—so far. Three factors are working together to contain the risks: the underlying shocks to inflation are coming from outside the labor market, falling real wages are helping to reduce price pressures, and central banks are aggressively tightening monetary policy.
A look at history
To better understand these dynamics, we identified 22 situations in advanced economies over the past 50 years with conditions similar to 2021 when price inflation was rising, wage growth was positive, but real wages and the unemployment rate were flat or falling. These episodes didn’t lead to wage-price spirals on average.
Instead, inflation came down in subsequent quarters and nominal wages gradually rose, helping real wages recover.
Although the shocks hitting economies are unusual, these findings provide some reassurance that sustained wage-price spirals are rare. But that should not be cause for complacency by policymakers—there are differences across episodes, with some showing worse outcomes. Inflation in the United States, for example, kept rising and real wages fell for a while after 1979, when the economy was hit by further oil price hikes. The inflation trajectory changed only when the Federal Reserve raised interest rates sharply.
The role of expectations
How expectations are formed matters a lot for wage and price dynamics and affects what actions policymakers should take after an inflationary shock. Inflation expectations became more important in explaining wage dynamics over the second half of 2021, according to an empirical analysis.
To study how expectations affect the economy, we used a model-based analysis, calibrated to reflect economic conditions in the first half of this year and taking the policy rate path as given.
When businesses and households expect future inflation to be the same as it is today, an inflationary shock can lead workers to demand even more to compensate for perceived higher future inflation. This kind of backward-looking expectations process—what we refer to as fully adaptive—can lead inflation to rise and stay above the central bank’s inflation target for a prolonged period even if there are no additional price shocks.
By contrast, when people’s expectations reflect all available economic information—referred to as rational—businesses and households see the shock to wages and prices as temporary, leading wage growth and inflation to quickly move back towards target and stay anchored.
In most places, the reality lies somewhere between these extremes, with businesses and households looking at what happened in the past (weighing recent quarters more heavily) to learn about the economy’s structure and make predictions, referred to as adaptive learning. In this case, wage growth and inflation can take longer to come back to the central bank’s target than when expectations are rational, but faster than when they are fully adaptive.
In all these cases, real wages tend to go down initially as inflation outstrips wage growth, helping offset some of the cost-push shock that fueled inflation and working against a wage-price spiral. But if inflationary shocks start to come from the labor market itself—such as an unexpected, sharp uptick in wage indexation—that could moderate the effects of falling real wages, pushing up both wage growth and inflation for longer.
For monetary policymakers, understanding the expectations process is critical. When expectations are more backward-looking, monetary policy tightening—including through clear communications by the central bank—should be stronger and more front-loaded in response to an inflation shock.
In that sense, recent tightening actions by many central banks—calibrated to economy-specific circumstances—are encouraging. They will help to prevent high inflation from becoming entrenched and inflation from deviating from target for too long.
This blog is based on Chapter 2 of the October 2022 World Economic Outlook, “Wage Dynamics Post-COVID-19 and Wage-Price Spiral Risks.” The authors of the report are Silvia Albrizio, Jorge Alvarez, Alexandre Balduino Sollaci, John Bluedorn (lead), Allan Dizioli, Niels-Jakob Hansen, and Philippe Wingender, with support from Youyou Huang and Evgenia Pugacheva.
Reprinted with permission; IMF Blog.
Week in Review Editorial Team:
Annacaroline Caruso, editor in chief
Jamilex Gotay, editorial associate
Kendall Payton, editorial associate