Supply and Demand, Again

The current macro environment has a variety of short- and long-term effects for our economy.

The Fed's latest Beige Book. It provided grounds for both optimism and pessimism, suggesting that inflation is starting to cool (Rah!), but also that economic activity is starting to slow (Boo!). While qualitative rather than quantitative, the Beige Book provides a more current picture of the economy than the assorted hard-number reports, which have a greater lag time.

Our Analysis - The problem is that, given the constraints on the supply side of the economy, lower inflation and a slower economy go hand in hand. While the notion that the current inflationary cycle is "transitory" has become a bad joke, neither is it quite yet "entrenched"; i.e., driven by future expectations rather than current economic conditions. But economic conditions have been quite enough to drive inflation on their own.

In recent years, the economy has undergone a series of abrupt changes, some of which were-relatively-temporary shocks (for math geeks, think impulse functions), while others appear to be semi-permanent alterations (think step functions). The temporary shocks included the Covid lockdowns (the mother of all shocks to both supply and demand) and the subsequent stimulus package, a supply shock. The effects of these are still being felt, but much of their impact has already worked its way through the economy. Had these been the only changes, inflation might have indeed been "transitory," as their effects would fade with the passage of time.

The semi-permanent changes include the war in Ukraine (which has drastically cut both global food supplies and European energy supplies), the decoupling of China from the rest of the world (politically driven, but accelerated by Covid), and the vanishment of millions from the American workforce (a demographic inevitability as Baby Boomers enter retirement, but also accelerated by Covid). These all are forcing permanent adaptations in the economy, the nature of which are not yet clear. Being largely reductions on the supply side of the economy, they have resulted in inflation. By raising rates, the Fed seeks to bring prices back to equilibrium by reducing demand to match. Unfortunately, unless supplies-of food, energy, and labor-can be increased again, higher interest rates, reduced demand, and slower growth may be part of the equation for a long time to come.

-PR

View/post comments

Wall Street Millennial Newsletter

Market moving news and analysis, concisely curated by Harvard and Oxford educated, former finance industry professionals.

Sign Up Now for FreePlease input a valid email address