The government is expected to rein in local government spending, tighten curbs on residential property purchases, and seek to reduce excess industrial capacity. But the slowdown is likely to be measured and the risk of a “hard landing” has narrowed. A Goldilocks economy but three grumpy bears may not be far away A striking feature of the global economy is how subdued inflation has been despite broad-based economic expansion and highly accommodative monetary policies. This benign inflation environment provides the runway for very gradual monetary policy tightening and credit conditions remaining accommodative for longer. Many analysts have characterised the current configuration of healthy growth, low inflation, and easy financial conditions as a Goldilocks scenario: a global economy that is chugging along, not too hot, not too cold. And financial markets see this happy scenario as self-reinforcing, sustained, and accommodated over multiple years. This has supported high equity valuations, low bond yields and narrow credit spreads. But as David Skilling reminded us recently, the Goldilocks story is not complete without the three bears. The absence of the bears does not mean they do not exist. They could return any time. There are unseen risks out there – that we ignore at our peril. Each of us will have our own list of three bears. Let me share with you what I see as the three bears that might return to spoil Goldilocks’ happy stupor. My “papa bear” is inflation; “mama bear” protectionism; and “baby bear” financial instability.
Part-time workers now make up about a third of the US work force, and many of them want to transit to full-time jobs. The labour force participation rate in the US remains near a cyclical low, at 63%. Even after accounting for the retirement of baby boomers, a meaningful segment of the population could re-join the workforce. If the labour market in reality is not as tight as the unemployment number suggests, then it is not surprising that wage growth has been weak. A second reason for low inflation has to do with the effects of globalisation. The integration into global production chains of workers from China, India, and the ex-Soviet republics during the 1990s and 2000s is estimated to have nearly doubled the size of global labour supply. This labour supply shock, facilitated by expanding global value chains, has exerted significant downward pressure on tradable goods prices. And the international outsourcing of production appears to have dampened the “pricing power” of labour and hence wage growth. A third explanation is technology. Industrial automation has exerted downward pressure on manufacturing wages. Likewise, advances in software programming and artificial intelligence are automating knowledge work and dampening wage increases in the services sector. More broadly, the spread of e-commerce has been eroding the monopolistic pricing power of traditional retailers and wholesalers of goods and services – the so-called “Amazon Effect”. I think it is premature to declare the Phillips Curve dead. Inflation will return when tightening cyclical factors outweigh the structural disinflationary forces.