Originally published by Melody Bomgardner on KelloggInsight. Based on the insights of Sergio Rebelo.
As we move into the third year of the pandemic, the global economy is still rippling from pricing and supply-chain disruptions—and it is not yet clear when those will fade. Add Insight to your inbox.
Many key economic indicators are moving in opposite directions. But we can still mine them for some clues about what’s coming, according to Kellogg finance professor Sergio Rebelo, speaking in a special virtual event for alums.
Here are five economic trends Rebelo says are worth monitoring. **
- Central banks are running to catch inflation, but there’s only so much they can do.**
The aspects of inflation consumers complain about the most—rising prices for gas and food—are not usually a focus area for central banks like the U.S. Federal Reserve. That’s because energy and food commodity costs are too volatile to manage with the tools of monetary policy. But as prices in general soared, the Fed has been forced to try to catch up by quickly raising interest rates.
When the Fed makes borrowing costlier, it can dampen an overheated economy by reducing demand for goods such as appliances, cars, and houses. Unfortunately, the Fed’s leverage does not extend to fixing problems with the supply of goods.
“In places like the U.S., the EU, and many countries in Asia, we have inflation caused by a combination of demand and supply shocks,” says Rebelo. “The recent burst of inflation was more of a supply than a demand phenomenon.”
Supply shocks are generally temporary. However, the U.S. risks tipping into long-term inflation caused by higher wages. “When unemployment is low as it is now, workers feel comfortable leaving their jobs and asking for big pay raises. If your company has increased wages, sooner or later, you have to increase prices,” says Rebelo.
2. Supplying the world with goods is getting cheaper, for the most part.
Pandemic-related shutdowns caused the cost of shipping goods around the world to soar, but that cost is returning to normal–with one notable exception.
“What has not normalized is shipping to and from China,” says Rebelo. “China has not vaccinated a lot of its elderly population, so every time it opens up, COVID deaths increase, causing more shutdowns.”
That means that the tight supply of goods such as automobiles that rely on computer chips from China likely won’t loosen up any time soon.
On the other hand, supply of commodity-based goods such as gasoline and food are starting to normalize. But consumers won’t soon notice extra money in their pockets, due to a phenomenon called “rockets and feathers.”
“When oil prices go up, gas prices go up immediately like a rocket, but when oil prices come down, gas prices come down slowly, like a feather,” he notes. “Most prices of items produced with commodities behave in this way. We see wholesale commodity prices come down, but it takes time for the retail prices that consumers pay to decline.”
3. Blame long-term trends for labor shortages.
Unemployment in the U.S. is about as low as it ever gets. Many workers are quitting part-time or temporary jobs they took as pandemic stopgap measures, while others depart in search of higher wages.
But employers should not assume that the current labor shortage is an aberration. They are facing a decades-long trend of reduced birth rates in the U.S. and around the world.
Economic downturns can also lower birth rates and shrink the pool of workers a generation later. “It takes about 26 years to produce a 25-year-old worker,” Rebelo jokes. “You can’t go back and undo those kinds of decisions.”
The demographic outlook is stark. For example, the number of U.S. people most active in the labor market—those aged 25 to 54—hit a plateau in 2000 after more than 40 years of steep growth.
A significant reduction in net migration to the U.S. compounds the labor shortage. In 2016, 1 million people per year came to the U.S. These immigrants helped the economy in two ways, says Rebelo: they filled jobs, and they had higher fertility rates. Now that flow has dwindled to 200,000 per year.
4. Employers are embracing remote work.
Don’t pay attention to those grumpy CEOs who post essays about forcing people back to the office. The reality is many businesses have learned that working from home, at least part of the time, significantly boosts productivity.
Studies on call centers and other workers in China showed that those who were randomly assigned to work from home had higher rates of productivity and lower rates of turnover and absenteeism, Rebelo says.
Other professionals, like software engineers and accountants, who require long stretches of uninterrupted time, have embraced work-from-home and hybrid schedules. As many as 40 percent of professional employees are now working from home at any given time.
The argument for going to the office a few days a week is that it may be necessary for collaboration and acquiring new skills.
“Working from home is great for things we already know how to do, but less good for things that we haven’t done before,” says Rebelo. “That’s probably why Elon Musk doesn’t like it.”
5. The world is taking steps to fight climate change.
The world still gets more than a quarter of its energy by burning coal. And the disruptions in the energy markets caused by Russia’s invasion of Ukraine and the resulting sanctions have interrupted the shift from coal to cleaner natural gas, particularly in Europe.
But there is good reason for hope on the climate-change front. Industrial investments in China have significantly decreased the cost of photovoltaic cells, making solar energy price-competitive in many places. And the U.S. is very close to implementing policies with attractive tax incentives for investing in renewable energy as part of the Inflation Reduction Act.
“This act might spark the beginning of a green revolution,” says Rebelo. He points out that news about the tax breaks has already boosted the value of an index of renewable energy stocks.
Another reason for hope is that countries joined forces once before to solve a climate problem by replacing the chemicals responsible for destroying the ozone layer.
“We can succeed again, but we need to rise to the challenge posed by climate change,” he says.