Inflation and employment crunches should start to relax in the year ahead as pandemic disruptions fade.
BY: JIM GLASSMAN, HEAD ECONOMIST, COMMERCIAL BANKING
GINGER CHAMBLESS, HEAD OF RESEARCH, COMMERCIAL BANKING
DEC 07, 2021
Prices should stabilize and monetary policy should turn back from the extraordinary pandemic measures in 2022—even as we continue to grapple with new variants of the coronavirus. Here are some of the economic trends that will define the year ahead.
The economy’s reopening has been accompanied by supply chain bottlenecks, worker shortages and the highest rate of inflation seen in three decades. The pandemic’s dislocations were clearly still with us throughout 2021, but the coming year could see a gradual stabilization as prices, consumer demand and monetary policy move closer to equilibrium.
- We expect 2022 to be another year of above trend growth, due to a buildup of household savings during the pandemic, replenishment of depleted inventories and ongoing support from monetary policy.
- Supply chain bottlenecks are beginning to ease. The flow of goods could soon be back to normal.
- Inflation should start to subside by the middle of 2022, but the early part of the year may see little relief from 2021’s runup in prices.
- A few million workers could return to the job market if pandemic stresses fade, but labor shortages are likely to persist.
- The Federal Reserve may move closer to a neutral monetary stance in 2022.
Inflation may be a tale of two halves
Strong inflationary pressure could persist through the first part of 2022, only to ease as the economy moves back into equilibrium.
- Prices did not begin rising rapidly until the spring of 2021, so year-over-year figures will be elevated through the first quarter even if prices stabilize sooner.
- Shipping bottlenecks are beginning to ease, but it will take months before imported components such as microchips find their way into cars, appliances and other finished goods. In the meantime, supply shortages may continue to push up retail prices for scarce goods.
- By the second half of 2022, the flow of goods should be closer to normal, greatly reducing inflationary pressure.
- In a November announcement, the Federal Reserve’s Federal Open Market Committee described long-term inflation expectations as “well anchored” at the 2% target.
Supply chains finally unsnarl
With overwhelmed ports and delayed shipments, we’re more aware of long-hidden stress points in the global supply chain. The supply of microprocessors, for example, has proven to be inelastic. A surge in demand for vehicles, appliances and electronics quickly outstripped the productive capacity of the world’s chip foundries.
The encouraging news is that shipping bottlenecks are already easing. The wait time for ships docking at the Port of Los Angeles is shortening, and more ships are departing U.S. ports loaded. Solid progress, but it will take more time before the flow of retail goods returns to normal.
- Asian manufacturers are back online. Export-focused economies such as Vietnam, Malaysia and Thailand are vaccinating a comparatively large share of their population. That makes another round of factory shutdowns in these economies unlikely.
- Demand for goods may ease in 2022 as the mix of consumption moves back toward services.
- The Bureau of Transportation Statistics’ Freight Transportation Services Index (TSI) measures the amount of freight carried across the country. In the most recent report, the TSI rose 1.3% to reach 135.8, ending a four-month decline. That’s right at pre-pandemic levels.
Workers are returning, but labor shortages could persist
Strong demand for labor should entice the last of the pandemic’s workforce dropouts to rejoin the job market, but demographic trends may still drive a long-term worker shortage. Even a return to pre-pandemic labor market participation rates and higher wages won’t reverse the aging of the American workforce or the slowing of immigration flows.
- Between 4 million and 5 million workers have yet to return to the job.
- Some are struggling to find childcare, while others with chronic health conditions may feel that their workplaces are still unsafe.
- With children back in school and booster shots widely available, the strong labor market should lure many workers back.
- The labor market should be highly favorable for workers reentering in 2022, with 10 million unfilled openings and a record-high 30% of small businesses planning to raise wages.
- The workforce is growing more slowly than in past decades, and has been for more than a decade. Businesses may have to adopt labor-enhancing technologies as workers grow scarce.
The foundations of demand are robust
Strong household balance sheets, depleted inventories and federal infrastructure spending are poised to drive economic demand in 2022. Personal consumption expenditures have risen 12% since 2020, and the ratio of disposable income to household net worth is nearing a record high.
- Government stimulus, along with the booming equities and real estate markets, have combined to create approximately $2.5 trillion in excess household savings. Those strong household finances should translate into another year of robust consumer demand in 2022.
- Supply chain disruptions depleted retail inventories, but as the flow of merchandise resumes, restocking backlogs could boost demand for manufactured goods by 6%.
- The recently passed federal infrastructure bill promises to fund a wide array of construction projects over the coming decade.
The Fed may shift toward neutral
A favorable economic environment could set the stage for a shift toward neutral monetary policy. The Fed has begun to taper its bond buying program, and asset purchases are scheduled to phase out by mid-2022 if not sooner.
- Early in the pandemic, the Federal Reserve extended emergency support to the economy. In addition to cutting interest rates to near-zero, the Fed has also been purchasing $120 billion of Treasuries and mortgages every month.
- This intervention set the stage for a rapid recovery when the economy reopened—the headline unemployment rate dropped 10.2 percentage points in 18 months, its steepest decline in history.
- Interest rates could begin to rise in 2022. Policymakers have been reluctant to raise rates in the face of ongoing pandemic risks; however, the strengthening labor market and persistent price pressures may set the stage for a return to a neutral monetary policy over the coming years.
- The liftoff is likely to be gradual. Each incremental hike will depend on the economy continuing to grow.
What to watch
COVID-19 cases. If the pandemic continues to fade, supply chain issues should resolve and labor market participation will rebound. A wintertime surge, however, could prolong distortions in the economy. We’re still waiting to learn more about the newly identified omicron variant of the coronavirus, and whether it will be more easily spread or more harmful than past strains.