In the rapidly evolving outlook for interest rates, some things are still sacrosanct. The pace of price increases has slowed significantly, and the argument is now how much — rather than when — borrowing costs will be lowered this year. Traders have latched on to the idea that relief will come by March, and some economists even flag a period of below-target inflation. The folks actually making the decisions sound unconvinced, and have fallen back on two lines of defense that can use a rigorous stress test.
Despite bets they will capitulate within months, officials cling to a couple of well-worn phrases: the last mile of the inflation fight is the hardest, and the very worst thing would be to declare victory. The assertions are related. They translate to “Don't push us, the spike of 2021 and 2022 remains too raw.” Christine Lagarde, president of the European Central Bank, chided traders last week and warned that speculation about cuts is unhelpful to policy deliberations. It's almost as if raising the issue is a punishable offense.
Salons in Davos last week were replete with denials that a win is at hand. Nor has the refutation been limited to chattering on the slopes. “Mission is not accomplished yet, but it's on track,” Ravi Menon, who led the Monetary Authority of Singapore, said in one of his last interviews before retiring from the civil service in December. The International Monetary Fund
recently urged officials to stand firm in “the very last mile” of the inflation fight. What did this last mile do to have warranted, in equal measure, such vilification and reverence?
A new paper from the Federal Reserve investigated the last-mile theory and found it wanting. David Rapach, an economist at the Atlanta Fed, wrote that the analogy is grounded in a long race where an athlete tires as the end is in sight and needs extra exertions to get there. The finish line is the 2 percent inflation target. The Fed's preferred measure rose 2.6 percent in November from a year earlier, within striking distance.
The concern is that the last stretch will require something more. Officials will need to extract an additional cost from the economy in terms of jobs and growth. However, it's not obvious to Rapach that the sporting analogy works. “For the last 1 to 2 percentage points of disinflation to be fundamentally more difficult than the preceding decline in inflation, there must be some sort of structural mechanism that makes the last mile different from the rest,” he argued. “Such mechanisms are not readily apparent in conventional macroeconomic models. Thus, the contention that the last mile of disinflation is more arduous deserves serious scrutiny.”
Rapach evaluated the notion that inflation in services, as opposed to goods, is particularly tough to repress. According to this popular school of thought, getting the cost of manufactured items down is relatively easy. Services, in contrast, are recalcitrant enough to warrant some additional tightening. But “sticky” doesn't mean harder, he wrote. It requires more patience, not necessarily some extra exertion.
This isn't some arcane econometric debate. The consequences of misreading the environment are potentially great, not just for the US. While America may have averted a downturn for now, the global expansion isn't in such fine shape. Gross domestic product shrank in Germany last year. There's skepticism that China's economy was healthy enough to have notched the reported 5.2 percent expansion. “From a risk management perspective, believing that the last mile is more strenuous could cause the Fed to tighten policy more than is necessary, which increases the likelihood of a recession and a sharp increase in unemployment,” Rapach concludes.
So what's wrong with declaring victory? Perhaps the last mile is hard not because of exhaustion, but ambiguity. This gray area was coming and was always going to be tough. If 2022 was about removing accommodation,
2023 was about shifting rates beyond neutral to a region that restrains business and consumers. The task was the same whether you sat around the table at the Fed, the ECB, the Reserve Bank of Australia or the South African Reserve Bank. Even the Bank of Japan let long-term market rates climb. Now comes the delicate part where actions and communication need to be more nuanced. It's important not to conflate a reluctance to be pushed around by traders as a rejection of cuts.
Officials probably just need more time to be convinced they won’t have egg on their faces again so soon after the “transitory” fracas. Reductions seem likely. It's just a question of when. Economists at Citigroup Inc. reckon global inflation will retreat to 3.2 percent this year, just slightly above its long-term average of 3 percent, and most major economies are likely to experience slower growth.
Capital Economics also suspects the last mile is over-rated and says the
return of too-low inflation is a growing risk. The current crop of central bankers don't want to go down in history as the second coming of Arthur Burns, the Fed chair in the 1970s often blamed for allowing inflation to escalate. They would rather be Paul Volcker, Neil Shearing, the firm's group chief economist told The Weekly Briefing podcast. But even Volcker started lowering rates in the early 1980s while inflation was still pretty high,
because he was convinced it had been broken. And the economic cost was high; the 1981-82 recession was one of the deepest on record.
Maybe they should just be themselves. I ran two half-marathons last year and would have competed in a third in December, were it not for a nasty knee injury. My coach was constantly telling me the struggles in the latter stages of such events are more mental, less physical. Block out how you feel and just know you will get to the finish line. One foot in front of the other.
One inflation reading at a time. Not that arduous after all.
Daniel Moss is a Bloomberg Opinion columnist. Views do not represent the stand of this publication.
Credit: Bloomberg
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