October CPI Leaves Faster Taper and Stronger Recession Risks

Summary

• The October CPI was higher than expected and showed broadening inflationary pressures.
• This likely reflects corporate pricing power: with profits at historical highs, firms lack incentive to expand production and address supply bottlenecks.
• Lowering inflation requires weaker pricing power – likely to happen via a continued decline in real household incomes combined with earlier, stronger Fed tightening than currently priced in.
• Alongside the stronger-than-expected NFPs, the October CPI increases the risk of a faster taper announcement at the December FOMC meeting.

Inflationary Pressures Broaden

Core CPI was 0.6% MoM against 0.4% expected and 0.2% in September. Most importantly, the October CPI shows inflation generalizing to most categories of goods and services (Chart 1). Contributing most to core inflation were core goods and services outside of shelter and core transportation – for the first time since the start of the pandemic. Annualized core inflation since February 2020, which strips out base effects, accelerated in October. Inflation is clearly not slowing, as I expected. 

Economic Concentration Drives Inflation Inertia

I think the persistence of high inflation mainly reflects corporate pricing power. The share of profits in income is at a historical high and rising, while that of workers is falling. That is the opposite of what happens in a typical recession: because workers are paid ahead of capitalists (profits are a residual), the income share of wages tends to rise and that of profits to fall in a typical recession.

This time, wages have lagged inflation and productivity. October wages were up 0.4% MoM in nominal terms, but deflated by the CPI, they will fall by 0.5% MoM. And real wages have not increased since mid-2020, while productivity has risen 6% (October NFP Support Faster Taper Announcement at Dec. FOMC Meeting). This reflects businesses’ stronger market power relative to workers; consequently, the Biden stimulus has benefitted large corporations more than workers.

A raft of anecdotal evidence shows producers are not responding to excess demand because it would decrease their profits. For instance, investment in chip capacity is targeting the more complex and profitable chips rather than the more commoditized and less profitable ones where excess demand is concentrated. Car manufacturers are similarly concentrating on the more profitable higher-end cars. And while firms are advertising many vacancies, they are not hiring – leading some jobseekers to call the supposedly hot labour market a ‘bait-and-switch’ market.

A Faster Taper Is Ahead

Disinflation will require weaker market power for large businesses. This can happen in two ways. First, the government calls out the offenders or enacts measures to prevent the most egregious abuses, which seems unlikely. While the academic community fully recognizes the consequences of a highly concentrated US economy on inflation and growth, such recognition has not percolated to economic policymakers, who seem more focused on climate change and inclusion.

The second path to weaker corporate market power is weaker demand, which seems more likely than government intervention. In turn, weaker demand will likely happen through two channels: real wages continuing to decline and Fed tightening. But the Fed wants to end taper before tightening. Following the stronger-than-expected NFPs, the October CPI increases the risk of a faster taper announcement at the December FOMC meeting.