# Connecting inflation to data

Finding positive perspectives on the months ahead.

Date:
June 2, 2022

We’re entering a rather complex economic landscape. When I reflect on my career, this is probably the first time that many of us have encountered inflation at this level. It’s the first time inflation has become so real and so present, with a figure as high as 8% in the US and double digits in many countries around the world. I don't think we've seen anything like it since the 1970s.

One complicating problem: inflation is often reported as just one number. And it’s like this abstract thing: we're told it’s this number, and that it's a bad number. Then we see it – it materializes right in front of you when you go to the pump. When you're buying food, when you're paying your electricity bill, you feel prices are going up. And you tie the two together.

But in reality, inflation is not really one number. It's derived from the sum of what we term “a basket of goods” – multiple things that go into what we would like to purchase every day, whether it’s electricity or food or the gas that we buy. Economists look at that basket of goods and ask, are prices going up or down? And then we weigh the different things in the basket. How important is it that electricity is going up versus the price of oranges? Some complex math leads to the single number we report as inflation.

But it doesn’t always match what we experience on the ground. That’s because, in part, the math that determines inflation is in no way standardized, and it's actually very tough to know the right way to do it.

What's the right stuff to put in that basket? What you buy every day is different from what I might buy every day, so who should the basket represent? Should it represent you better or me better, or some mix of the two of us? To further complicate things: Different countries have different methods of determining inflation, too.

So what we call “inflation” is by no means standardized, and that’s a tricky problem. Even though many of us have developed very sophisticated equations in search of a more “believable” number, what we call “inflation” is actually full of data and variables that many economists dispute and argue with.

Right now, in response to very visible higher prices, the Fed has taken hard action, raising their base interest rate with a 0.5% increase, which controls the cost borrowing, with the intent of slowing spending, lowering demand and bringing prices down.

We’ve already seen a cascade of consequences. But the next question presses hard: when will it work? When will inflation ease and prices come down?

As an answer, let me point to some more data and try to explain what it might take for inflation to ease up.

Many of the goods and services we buy have long chains behind them, before we get the final product. That’s what people typically call “supply chains.”

Those chains stretch long and actually lead to other countries. Like the country where the oil is pumped before it's ultimately refined, even if it might be refined on US soil. Or where textiles are produced before they're turned into fashion that’s sent our way here.

If there's something happening way down the chain, like issues in production and supply lines, that gradually filters through. What’s happening today in a toy factory in East China might impact how much we pay months from now. Right now, factories are shut down because of COVID, and maybe in a month or two months, or even up to six months, there's going to be an increase in the price of toys bought in the US.

We can't see that immediately. There's not enough data around the world to catch all the factors involved. That's why it's so hard for anyone to know, to say with real certainty what will happen six months from now or even next month, to track all the effects that are going to flow through. East China’s COVID shutdowns are just one example of what’s going to impact our inflation rate. It’s very hard to predict.

In some ways, the goal of an economist is to get as many leading indicators as possible. When it comes to economics, it's always about the data, its quality and its timing. But we also don't live in a world of real-time data.

The moment you get a report that says, Hey, the number of US jobs increased! Or the inflation rate has gone up! – you get a fast reaction to just that single report. We see markets swing just for that reason. It’s news for everyone.

If we hear news that things are loosening in China with COVID management, and they're allowing people to get back to factories, that's a good sign that things are looking better for the price of goods and services in the US. When we eventually hear that news, we should expect to see a reaction in US markets and prices.

Here’s another data point: we've come out of a pandemic, and people have real exuberance, they want to spend on vacations, restaurants and going out buying more stuff. That's going to push up demand and keep pushing up prices. Things can't be supplied fast enough, because demand is up and there are real blockages down the supply chain.

But telling people to pull back is not the answer. That can potentially do more damage to the economy. We want people to spend, we want to bring our economy back to life, to keep fueling very positive growth. If you pull back on spending, it actually can have detrimental effects on growth.

One of the big questions right now, especially given the Fed’s effort to slow our spending: are we headed into some form of contraction, where the economic output actually shrinks over the next year or two?

It's a very confusing time. Typically macroeconomic indicators, things like inflation and employment, signal the level of growth. We also look at the trade surplus between the US and other countries. If you look at the unique combination of these variables right now, it's quite a unique combination.

We haven't often seen this in the last 50 to 60 years of our economy. What it's caused, as a result, is a lot of hesitancy, especially when you add the fact that the stock markets have had a couple turbulent weeks. People are wondering what's actually happening with our economy.

My personal view is we are not heading into a recession. People want to spend the savings they built up during the pandemic, and that’s going to increase output as well. You see it in the labor market: there were actually 11 million more jobs available than people looking for work.

At the same time, you have this weird inflation, a very high inflation figure, plus a couple of other concerning things, like what's happening with the stock markets. People have good reason to be confused, but we're going to have a rebound. Things will settle. And stock markets will adjust. In my personal view, the current turbulence will pass and inflation will come down. But it might take the next 12 months to come back to something reasonable.

I hope we can be positive about the months ahead. We should be positive. I'm very positive. There are good signs that things can come back and stay strong.

Article by
Avi Patchava
CEO (joint)

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