Productivity v inflation

Over the past several months, inflation has moderated substantially from its peaks in 2022 as some of the transitory factors fade (energy prices, global supply chain disruptions).  However, the remainder of the disinflationary process is likely to be challenging, as last week’s US inflation reading reminded.

My assessment is that we are moving into a period of structurally higher inflation across advanced economies.  This is due to factors such as: persistently tight labour markets, reinforced by aging populations; increased frictions in global supply chains, with an increased frequency of shocks and distortions caused by geopolitical rivalry; as well as expansionary ‘wartime’ fiscal policy, as governments increase spending/investment on defence, industrial and innovation policy, the net zero transition, and so on (see my recent note on geopolitics and macro policy). 

There will be some countervailing forces.  For example, there will be a deflationary impulse from Chinese over-production in sectors like EVs and renewables (as discussed in last week’s global briefing note), although this effect will be constrained by pushback from some importing countries that impose trade restrictions.

Productivity & inflation

The most powerful offset to the structural increase in inflation would be a material, sustained positive supply-side shock: a ‘productivity renaissance’ that allows stronger, non-inflationary growth to be sustained.

Labour productivity growth has been in decline across most advanced economies over the past several decades; and productivity growth flattened off again in the decade after the global financial crisis.  But there is potential for productivity growth to return strongly.  The pandemic was a useful forcing event in this regard.

The full note is available at: https://davidskilling.substack.com/p/productivity-inflation-and-geopolitics