Since the late 1980s, investors have benefited from a mostly calm and predictable macroeconomic backdrop with low and stable inflation, long business expansions and few recessions.
The global economy looks different today, with inflation at 40-year highs, undulating stock markets, disrupted supply chains, rapid interest rate hikes and a war in Europe. Has the era of “The Great Moderation” come to an end?
In episode 47 of The Flip Side, Global Chairman of Research Ajay Rajadhyaksha and Senior US Economist Jonathan Millar debate whether the current raft of economic and geopolitical challenges is cyclical or structural, and what that may mean for the global economy in the years to come.
Ajay Rajadhyaksha: Welcome to the Flip Side. My name is Ajay Rajadhyaksha. I'm the Global Chairman of Research at Barclays. And I'm joined today by Jonathan Millar, our Senior US Economist. Thanks for joining me, John.
Jonathan Millar: Thanks for having me, Ajay.
Ajay Rajadhyaksha: Today, we are going to discuss whether the world economy has changed permanently and for the worse. Now, for most of the last 30 years, the world saw low and stable inflation and long business expansions. Recessions were few and far between. It is a period that we like to call the Great Moderation. The question is, has that ended? Will the next decade be far more volatile?
Jonathan Millar: Well, Ajay, I'm going to be taking the stance that the great moderation really has ended. Just look at the last few quarters. Inflation at 40-year highs, quarterly GDP numbers that bounce around, major central banks hiking rates more rapidly than we've seen in decades. Even last week, the ECB broke its own forward guidance following the Fed's lead from June. Financial markets go up one week, then plummet the next week. We're moving into an era of far more economic uncertainty.
Ajay Rajadhyaksha: And I will take the other side, John. Yes, the world got hit badly first with the pandemic and then the energy crisis this year. But once central banks wrestle inflation back under control, we are going back to a period similar to pre-2020. Steady if unremarkable growth, limited job losses even in downturns, steadily rising equity and bond markets. And, yes, low inflation.
Jonathan Millar: Well, exhibit A for my argument is how much the jobs market has changed since 2020. Just before COVID, the US jobless rate was where it is right now, but annual wage inflation was 2.7%, according to the Employment Cost Index. Now, wage increases are about 4.5%, roughly double that pace with the exact same jobless rate. And the US is still creating 400,000 jobs a month, which is far more than what is typically needed to keep the jobless rate steady.
That means the demand exceeds supply, which could cause wages to accelerate even further. And you know this Ajay. With wages rising so fast, it will be difficult for inflation to return to 2% anytime soon. Prior to the pandemic, wage inflation stayed low for years and years, and the lack of pressure to raise wages was a big part of the reason that inflation stayed low, even as the unemployment rate fell below what was considered full employment.
Ajay Rajadhyaksha: Okay. Two points here, John. First, wages are running at four and a half percent, but inflation is nine. That's hardly conclusive. Wages might just be being pulled up temporarily by high inflation. And when inflation comes down next year, so will wages. And second, I very much doubt that the US will keep creating 400,000 jobs a month going forward. Economic activity is slowing down hard and so will job creation. This rise in wages is not a permanent change.
Jonathan Millar: But Ajay, I think you're kind of overlooking why wages are rising, which has everything to do with the scarcity of workers. People dropped out of the workforce during the pandemic, and many of these workers aren't coming back. The labor force is still running short of pre-pandemic levels, even though we now have 4.2 million more working-age adults. That means we're trying to provide goods and services to more and more people using fewer workers. When you look at it this way, of course, wages are going up.
Ajay Rajadhyaksha: Look, I will agree that some people have permanently left the workforce relative to the absolute peak of labor participation in 2019. But on the other hand, technological improvements and globalization, these are factors that have been restraining wages for decades. I think you are underestimating, John, how strongly these factors will come back. And much of the drop in the labor force simply brought forward retirements that would have eventually occurred anyways.
Jonathan Millar: Okay. So now that we've broached the topic of globalization, let's shift gears and talk a bit about global supply chains. These are another worry for me. For years, companies built factories where costs were lowest, splitting the production process into tiny bits across the globe. They use just-in-time inventory management to keep costs low, relying on global transportation networks to keep everything in perpetual motion. A semiconductor chip that was designed in the US could be made in Taiwan, packaged in Malaysia, and then shipped all the way back to the US.
And this all happens seamlessly, and that efficiency kept prices low. But those days are gone. COVID completely mucked up global supply chains. Look at autos. Car prices have shot up to crazy levels because parts were not available. This is emblematic of what has happened to so many products triggering more months and months of shortages and cost pressures.
Companies are never going to be that vulnerable again. They're moving production onshore, but that's more expensive. The process will take time, and it will involve its own share of headaches. It will keep economic volatility high, and the more onshoring occurs, the greater the bargaining power of local workers.
Ajay Rajadhyaksha: Once again, I think you are overestimating the impact here. If everyone is moving production away from, say, China, how come Chinese exports have been so strong for two years and even last month? And yes, prices went up an enormous amount last year. And yes, part of that was because supply chains broke down, but it was also partly because goods consumption absolutely exploded last year, John. Consumers went out and seemingly bought every computer screen in sight, and no one foresaw that.
Jonathan Millar: Well, why not? Why didn't policymakers forecast any of this? The federal government was giving people money and the Fed was buying financial assets on an immense scale. Wasn't runaway inflation virtually guaranteed? And yet, look at how badly every central bank missed how high inflation would go. Admit it, policymakers might not understand the economy as well as we thought they did. And if the world has become so complex that policymakers don't understand it, that's a worrisome development. And it's not like it will be any less complicated six months from now.
Ajay Rajadhyaksha: Oh, come on. 2021 also saw a huge COVID wave that no one expected. Remember Delta and then Omicron, those threw a spanner in the works. Then there was the Russia-Ukraine war, which was a giant new energy shock. That's a lot for the economy to absorb or for a central banker to forecast. But here's the thing. None of these are permanent changes.
Jonathan Millar: Well, there always seems to be some excuse, isn't there? Now, China is facing lockdowns in a bunch of places and that will cause new and unexpected global supply chain problems as well, Ajay. And it may be a mistake to think the policymakers won't misread those as well.
Ajay Rajadhyaksha: Well, the harshest China lockdowns were in Shanghai in April, so that should have shown up in the economic data by now. And yet every survey in recent months in both the US and China suggest that Chinese supply chain issues are easing, not worsening. So I'm optimistic on this issue. But more generally, John, the notion that policymakers have suddenly stopped understanding the economy after decades of managing it, that's just a bit too harsh.
Jonathan Millar: Well, Ajay, what about their actual words? Last month, even Christine Lagarde herself admitted this. She said that forces unleashed by the COVID pandemic, Russia's war in Ukraine, and the breakdown of global supply chains have made the return to a world of low and stable inflation difficult to achieve. Jerome Powell also acknowledged that the post-pandemic economy was being driven by forces that central banks just don't understand.
Ajay Rajadhyaksha: And yet Powell has also expressed confidence about the US returning to 2% inflation. And so has Lagarde in Europe. Market pricing of US inflation over the next decade has dropped massively over the last month. The Fed is forecasting, meanwhile, that the jobless rate will peak at 4.2%. Now, yes, that is higher than now, but 4.2 is low, John. This is hardly the new, uncertain, more volatile regime that you speak of.
Jonathan Millar: Well, there's one other critical factor to consider, Ajay, geopolitics and their role in instigating an energy crisis. Look at Europe. Natural gas prices there are running eight times the level in the US. To put this into perspective, it's as if the ECB is trying to manage a run-up at oil prices to $300 a barrel when the price in the US is at $40 a barrel. And even if the Ukraine war magically ends tomorrow, sanctions will not be quickly lifted.
In fact, Europe itself believes that the breach with Russia is permanent. That's why they're trying to wean themselves off Russian gas, building LNG terminals, signing deals with Qatar and Algeria. But that transition will be a long, hard slog. Years and years with lots of volatility and hits to their economy during the process.
Ajay Rajadhyaksha: So in this case, I do agree. Europe's energy problems do seem likely to last for years, but I don't think you can extrapolate to the rest of the world. Like you said, the United States does not have a natural gas problem and even on oil, prices are now down 15% from early June.
Jonathan Millar: But we're still at $100 a barrel, Ajay. Remember for years we depended on the US shale industry. If oil prices rose, fracking activity increased and so did supplies of shale oil and natural gas. That kept energy prices, and particularly oil price is well in check. I suspect those days are gone. The easy pickings in the US shale patch are over.
And even if not, private lenders will be wary about funding another boom-and-bust cycle. And this doesn't even begin to account for the role of ESG, which means there is less capital for exploration. Even if energy prices keep rising, energy insecurity is a big part of the economic uncertainty of the future.
Ajay Rajadhyaksha: So first, I'm not so sure about US shale not responding. US [inaudible] have been rising this year. But even if you are right, I would argue that the bulk of the damage from energy is done. Oil is up 60% from 12 months ago. Say we stabilize here. That's okay. The economy has now adjusted. For energy to cause similar problems over the next 12 months, we need to see another 60% increase in prices. Are you telling me that's going to happen? That seems very unlikely, John.
Jonathan Millar: But Ajay, this misses the underlying point. All of these factors, the remaking, and reshoring of supply chains, the process of deglobalization, intensified energy and security, structural declines in labor supply. These are all happening at once. These all seem to be long-lasting influences, and they're likely to leave us with a far more uncertain world for years and years to come.
Ajay Rajadhyaksha: And my underlying point is that these are all temporary factors. Yes, they have lasted for longer than expected, but they are all cyclical in nature, not structural. Eventually, the focus will shift back to costs. Supply chains will be re-established. Technology and globalization will continue to help keep inflation low. And we will be back to a world not unlike the one before COVID.
Jonathan Millar: Well, Ajay, this is one of those cases where I clearly hope that you're right and then I'm wrong. Your view of the world is far more pleasant than mine.
Ajay Rajadhyaksha: I guess this is one debate, John, where the answers won't be immediately clear. And we, you and me, as well as our research colleagues will, of course, update our views from time to time as we do get more clarity.
For now, though, our listeners can read our most recent research piece on this topic titled, A New Era of Instability, published in our latest Equity Gilt Study in mid-July, and available on Barclays Live.
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This podcast series features lively debates between Barclays’ Research analysts on important topics facing economies and businesses around the globe.
About the analysts
Ajay Rajadhyaksha is Global Chairman of Research at Barclays, based in New York. He drives the global macro research and strategy effort including economics, rates, FX, commodities, emerging markets, and asset allocation. Since joining Barclays in 2005, Ajay has held various positions, including Head of Macro Research, Co-Head of FICC Research and, before that, Head of US Fixed Income Research and US and European Securitised Research.
Jonathan Millar is Senior US Economist at Barclays in New York. He has expertise in monetary policy, productivity, business investment and the industrial sector. Prior to joining Barclays, Jonathan was a Principal Economist at the Board of Governors of the Federal Reserve in Washington, DC. He also spent two years in Paris as an economist with the Organisation for Economic Development. Prior to these roles, Jonathan taught economics at the University of Michigan and had positions at the Bank of Canada, at the IMF, and as a specialist in energy derivatives at DTE Energy Trading.