What Is Immaculate Disinflation? Can America Escape Being Trapped With Inflation?

What Is Immaculate Disinflation? Can America Escape Being Trapped With Inflation?

immaculate disinflation

People gather for food at Harlem's Food Bank For New York City, a community kitchen and food pantry, Nov. 16, 2020. (AP/Bebeto Matthews)

Inflation is changing directions. Economic growth is slowing but still in plus territory. The labor market is resilient. These all point to “immaculate disinflation,” with the U.S. economy returning to normal without collateral damage to the labor market, some economists say.

But it’s too soon to rule out a hard landing or recession, wrote Andrew Flowers, a labor economist at Appcast, a recruitment advertising technology company.

There are several ways that unacceptably high inflation could fall to the Fed’s target level of 2 percent. One of those ways — the so-called “easy way” — is immaculate disinflation, according to Federal Reserve Bank of St. Louis economist William R. Emmons.

In this scenario, inflation falls fast from around 6 percent through September 2022 to 2 percent by 2023 or 2024, and stays there.

Immaculate disinflation is the most optimistic scenario of three scenarios outlined by Emmons. It would involve a “soft landing,” where inflation and the steps needed to reduce it cause minimal damage to the overall economy. In this scenario, there may still be an economic recession but it will be a mild one.

For this scenario to work, the Fed would need to avoid a wage price spiral, in which inflation leads to employees demanding higher wages, causing businesses to pay higher costs and, as a result, to increase prices, leading to more inflation.

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Past experience suggests soft landings are rare, according to The Economist. The longer inflation is allowed to continue, the harder it is to fight—and the Federal Reserve engaged in inflation denial for years. The White House and top Federal Reserve economists called inflation “transitory” until almost two years into the covid pandemic. For most of 2021, the central bank said that it had the tools to slow price increases but saw no need to put them to use, according to the Buttonwood column.

Although bond investors are bracing for recession with the Fed expected to slow the pace of tightening, macro analyst Alfonso Peccatiello argues that the bond market’s base case is not a recession — it’s immaculate disinflation.

Peccatiello is the founder and CEO of The Macro Compass, a disruptive investment strategy firm on a mission to democratize professional macro analysis, tools and portfolio strategy.

“A relaxed credit market, inflation rapidly declining to 2%, the Fed cutting rates back to neutral, forward real rates still expected in positive territory, and the lack of aggressive insurance bid for recessionary cuts all point in that direction,” Peccatiello wrote in a column for Investing.com.

Fed Chairman Jerome Powell identified successful soft landings in 1964, 1984 and 1993. But the present situation is different and difficult, The Economist reported. And in none of those cases did the Fed let inflation rise as far as it has today.

A second scenario on how inflation could end would be “the hard way: Paul Volcker returns,” according to the St. Louis Fed. Volcker was the Fed chairman from 1979 to 1987 and famously led a radical switch in monetary policy that helped move the country from double-digit inflation to inflation in the very low single digits. However, Volcker raised interest rates as high as 21.5 percent in an attempt to get runaway inflation under control, sending the U.S. into recession, for which Volcker received death threats.

The Volcker scenario was like “having root canal surgery without anesthesia” Emmons said.

The third scenario for how inflation could end is called the “Default Option: Stagflation” — a combination of a stagnant economy—that is, slow or weak growth in gross domestic product (GDP)—and high inflation. This scenario involves a long period of high inflation and high unemployment” Emmons said. Inflation oscillates and could take a decade or more to become permanent.

It may be the disinflation scenario the U.S. is left with if conditions for the first two don’t materialize, Emmons said. The last era of stagflation in the U.S. was from 1967 to 1982. During that period, there were four recessions, average annual inflation was 6.5 percent, the unemployment rate averaged 6 percent and
Inflation exceeded the previous 15-year average in every year.

How will inflation end?

“The recent predictive record of both central bankers and bond markets has been poor,” Buttonwood reported for The Economist.