Inflation—How Transitory Is ‘Transitory’?
The article below is from our BRIEFINGS newsletter of 28 October 2021
Rising price pressures are raising doubts about whether the surge in prices is temporary or something more permanent. We sat down with Goldman Sachs Research’s chief U.S. economist David Mericle for his latest views on the inflation outlook.
David, can you walk us through your forecasts on inflation and where you see it heading into year end?
David Mericle: So we're now at a three-decade high on core inflation and I expect it to get worse before it gets better. I have core personal consumption expenditure (PCE) inflation ending the year at 4.3% and staying in the 4% neighborhood through the first quarter of 2022. After that, I expect inflation to come down pretty sharply in Q2 and Q3 and to reach 2.15% year-on-year by the very end of 2022. That's partly just because of extreme base effects dropping out next spring. We're not going to see used car prices rise another 40% next year, for example. But it's also driven by our assumption that we will see enough resolution of supply-side problems and enough moderation of demand for goods as fiscal support fades to rebuild inventories. That should then cause durable goods prices to revert a little bit back toward pre-pandemic trends from what are now pretty lofty levels.
So why do you expect prices to partially revert back to trend on durable goods?
David Mericle: Well, for things like used cars, prices are flexible in both directions. And once you can actually get your hands on a new car, no one is going to pay the same price for a used car as for a new car, as they are now. In other categories, such as new cars, furniture and appliances, a lot of what has been counted as abnormally high inflation this year is actually an elimination of discounting. If you're a retailer, for example, and you have limited inventory and are bound to sell out, you don't put anything on sale. As long as supply-demand imbalances are eventually resolved, prices on some items like used cars partially normalize, and normal sales and discounting come back on other goods where shortages have widened retail margins this year, we should see some one-time deflationary payback next year for this one-time inflationary surge this year. So this is the distinguishing feature of our inflation forecast next year. I expect these supply-constrained durable goods categories to go from contributing about 140 basis points at the end of this year to being a big drag of 60 basis points at the end of next year, a swing of about 200 basis points. That's the main reason we expect core PCE inflation to fall from the low 4s at the end of 2021 to the low 2s at the end of 2022. Basically, we're assuming that very stretched durable goods prices this year mean payback next year and probably even a little into 2023. In contrast, the break-even market—which reflects investors’ inflation expectations in the Treasury markets—seems to be assuming this means momentum, not payback, for next year. Admittedly, it’s hard to know.
Are there other sectors that could still see higher prices?
David Mericle: The drop-off of prices on the goods side will be partially offset by faster inflation in some services categories. In particular, shelter is going to keep accelerating, due to labor market improvement and spillover effects from this huge boom in home prices that we've seen. And prices will keep accelerating in low-paying sectors like restaurants where wage costs have grown very quickly this year. A lot of forecasters have suddenly begun emphasizing these more persistent service-sector pressures after the September CPI report but none of this is really new. We've been predicting and writing about both of these trends since the spring and none of it is actually controversial. I think the controversy and uncertainty for 2022 are really more on the goods side.