Increasing trade barriers. Aging population. A broad transition from carbon-consuming fossil fuels to renewable energy.
The occurrence of such trends around the world could intensify global inflationary pressures in the coming years and make it more difficult for the Federal Reserve and other central banks to meet their inflation targets.
That concern was a theme that emerged in several high-profile speeches and economic studies presented Friday and Saturday at the Fed’s annual conference of central bankers in Jackson Hole, Wyoming.
For decades, the global economy has moved toward greater integration, with goods flowing more freely between the United States and its trading partners. Lower-wage manufacturing abroad allowed Americans to enjoy cheap goods and kept inflation low, though at the cost of many U.S. manufacturing jobs.
However, since the pandemic, this trend has shown signs of reversing. Multinational corporations have shifted their supply chains from China. Instead, they are trying to produce more products — especially semiconductors, critical to the production of cars and electronic goods — in the United States, with the encouragement of huge subsidies from the Biden administration.
At the same time, large-scale investments in renewable energies could prove disruptive, at least temporarily, by increasing government borrowing and demand for commodities, driving up inflation. A large part of the world’s population is aging and it is increasingly less likely that older people will continue to work. These trends could act as supply shocks, similar to the goods and labor shortages that accelerated inflation during the recovery from the pandemic recession.
“The new environment paves the way for greater relative price shocks than we saw before the pandemic,” Christine Lagarde, president of the European Central Bank, said in a speech on Friday. “As we face both higher investment needs and greater supply constraints, we are likely to see increased price pressure in markets such as commodities – especially for the metals and minerals critical to green technologies.”
This would complicate the work of the ECB, the Fed and other central banks, whose mandate is to keep price increases under control. Nearly all central banks are still struggling to contain high inflation, which has increased in early 2021 and only partially eased.
“We live in a world where we can expect more and perhaps bigger supply shocks,” Pierre-Olivier Gourinchas, chief economist at the International Monetary Fund, said in an interview. “All of these things make things harder to produce and make it more expensive. And that is definitely the configuration that central banks hate the most.”
Changing patterns in global trade patterns drew the most attention during Saturday’s discussions at the Jackson Hole conference. A paper presented by Laura Alfaro, an economist at Harvard Business School, shows that after decades of growth, China’s share of U.S. imports fell by 5% between 2017 and 2022. Her research attributes the drop to tariffs imposed by the United States and efforts by major US companies to look for other sources of goods and parts after China’s pandemic shutdowns disrupted production.
Most of those imports came from other countries such as Vietnam, Mexico and Taiwan, which have better relations with the United States than China – a trend known as “friendshoring.”
Despite all the changes, US imports hit an all-time high in 2022, suggesting that overall trade has remained high.
“We are not yet deglobalizing,” said Alfaro. “We see a looming ‘great redistribution’” as trade patterns change.
She noted that there are also tentative signs of reshoring – the return of some production to the United States. Alfaro said the United States is importing more parts and unfinished goods than before the pandemic, suggesting more final assembly is taking place domestically. And the decline in US manufacturing jobs appears to have bottomed out, she said.
Still, Alfaro cautioned that these changes also come with drawbacks: Over the past five years, the cost of goods from Vietnam has risen by about 10% and that from Mexico by about 3%, adding to inflationary pressures.
In addition, she said, China has increased its investment in factories in Vietnam and Mexico. In addition, other countries that ship goods to the United States also import parts from China. These developments suggest that the United States has not necessarily reduced its economic ties with China.
At the same time, some global trends could reverse in the coming years and bring inflation down. One of those factors is the weakening of growth in China, the world’s second largest economy after the United States. With the economy struggling, China will buy less oil, minerals and other commodities, a trend that should put downward pressure on the global cost of those commodities.
Kazuo Ueda, governor of the Bank of Japan, said during a discussion Saturday that while China’s sputtering growth is “disappointing,” it stems mainly from rising defaults in the bloated real estate sector, rather than changes in trade patterns.
Ueda also criticized the increased use of subsidies to support domestic production, as the United States had done for the past two years.
“The widespread use of industrial policies worldwide could just lead to inefficient factories,” Ueda said, because they wouldn’t necessarily be in the most cost-effective locations.
And Ngozi Okonjo-Iweala, director general of the World Trade Organization, defended globalization and also denounced rising subsidies and trade barriers. World trade, she claimed, often limits inflation and has helped significantly reduce poverty.
“Predictable trading,” she said, “is a source of disinflationary pressures, reduced market volatility and increased economic activity. …Economic fragmentation would be painful.”
