Both India and the US are headed for major elections next year in April-May and November respectively. How their economies perform this year and closer to the polls — in terms of growth, jobs generated, inflation and real incomes — would matter to Narendra Modi and Joe Biden.
From this point of view, official economic data released this month for both countries contain reasons for concern.
US inflation, unemployment
Start with the consumer inflation numbers for the United States, based on the Personal Consumption Expenditure (PCE) price index prepared by the Bureau of Economic Analysis.
The overall PUC price index for January was 5.4% higher than its level in the same month of 2022. PUC core inflation, which excludes changes in energy and food consumer prices that tend to be more volatile, was 4.7% on an annual basis.
Both “headline” and “core” inflation are running well above the US Federal Reserve’s 2% target. While the former has fallen from a June peak of 7%, the latter, considered a more accurate gauge of the underlying inflationary trend in the economy, is stubbornly stuck at around 5% (Chart 1).
But more than year-over-year (January 2023 over January 2022), it’s month-over-month inflation (January 2023 over December 2022) that was the shocker from the PCE price index data released on February 24. prices compared to the previous month amounted to 0.6%, which turned into an annual rate of 7.2%. Chart 2 shows that this monthly increase is the highest since May for the general and August for the core index.
The above data should be viewed in conjunction with the US Bureau of Labor Statistics’ previous employment situation report, released on February 3. It showed total nonfarm payroll employment rising 517,000 in January against an average monthly gain of 401,000 in 2022 — up from 568,000 in July.
In addition, the unemployment rate, from 3.4% in January, fell to its lowest level since May 1969.
Implications of monetary policy
January inflation and employment data indicate two things.
First, inflation rebounded after seemingly retreating toward the end of 2022, though even those numbers were well ahead of the U.S. central bank’s goal of keeping the annual rise in the PCE price index to 2%.
Second, falling unemployment, which reflects labor demand outstripping supply, complicates the Fed’s job. A tightening labor market — going “out of balance,” according to Fed officials — puts upward pressure on wages and, in turn, increases inflation.
How is the Fed responding? Given its commitment to price stability and a return to 2% inflation, it has no choice but to raise interest rates further. As credit becomes more expensive, businesses and consumers will hire and spend less. A slowdown in economic activity will then reduce aggregate demand, help cool overheated labor markets, and ultimately bring inflation under control.
However, it is important to note that the Fed has already raised the funds rate significantly – from a target range of 0-0.25% until March 16, 2022 to 4.5-4.75% at the last meeting of the Federal Open Market Committee on January 31 – February 1.
A further hike would risk what economists call a “hard landing.” When inflation is constant at 5% and the target is 2%, interest rates will have to rise high enough and fast enough to stay at those levels until economic activity moderates sufficiently.
That would mean a sharp decline or recession just before the US presidential election. That’s the opposite of subdued growth or a mild recession (“soft landing”), whereby the Fed must raise rates only slowly and by small amounts to bring inflation down to, say, 3% and cool an economy that it is not so overheated.
An indication of where interest rates are heading is provided by yields on 10-year US Treasury bonds. Between February 2 (before the jobs report) and February 24, these – basically what the government would pay for a 10-year loan – rose from 3.40% to 3.95%. Clearly, the markets have significant monetary tightening by the Fed in the coming days.
Dismissals and resignations
How does all this fit with the mass layoffs by Amazon, Google, Microsoft, Meta, Tesla, Salesforce, IBM, Ericsson, Zoom and SAP?
One reason may be related to job cuts occurring more among skilled and better-paid employees, especially at technology companies that were likely to overemploy earlier.
A second factor may be the shrinking US labor force relative to its working-age population (ages 16 and over). That ratio — called the labor force participation rate — fell from 63.1% in 2019 to 62.2% in 2022. In other words, nearly 1% of working-age Americans who were employed or looking for work before the pandemic have left the labor force.
The third, more interesting explanation comes from Jongseok Shin, a professor of economics at Washington University in St. Louis. In a recent paper by the National Bureau of Economic Research, it estimated an average decline of 11 working hours per person per year in the US between 2019 and 2022. The labor market is tightening not only because fewer Americans are working; even those who work choose to work fewer hours.
One of the more lasting legacies of the pandemic is the “Great Resignations” and the “Quiet Abandonment.” In Sheen’s description, these are people who decide to “recalibrate their work-life balance toward fewer hours.” The various cash transfers and economic relief extended during the pandemic would also enable such a reassessment of life’s priorities.
The situation in India
The Reserve Bank of India (RBI) faces a similar dilemma, with January’s downward trend in consumer price index (CPI) inflation reversing. The central bank’s mandate requires it to maintain annual CPI inflation at 4%. Although this target is subject to an “upward tolerance limit” of 6% – making it less rigid than the US Fed’s 2% – even these levels were breached for both headline and core inflation in the last published month (Chart 3).
The biggest source of uncertainty for the RBI now is the impact of higher-than-normal temperatures on wheat and other rabi crops, due to be harvested from late March. If temperatures rise further, as they did last March, it could reignite food inflation. Rural wage growth also appears to be underway, with the average annual rate increase outstripping CPI inflation since November.
Like the Federal Reserve Bank, the RBI has also raised its benchmark repo rate from 4% to 6.5% from early May 2022.
How much more can be raised to reduce demand – and risk a “hard landing” – would likely be a function of electoral constraints as much as the economy.