How Could Three Major Global Trends Affect Future Inflation?

Sometimes at first look, it may seem clear which global forces will be inflationary or deflationary. But an array of complex factors can make the net impact of these forces more ambiguous and more modest than many might initially think.

For example, in our last economic cycle when inflation ran peacefully below 2% for a considerable time, many commentators thought certain emerging forces in the economy – namely, globalization, new technologies, global shifts in the working-age population and the Amazon effect (the impact of the increase in online shopping on brick-and-mortar retail) – would help keep prices under control. Given that these forces were structural rather than transitory, they believed these ideal conditions would persist for years. Our colleagues in Goldman Sachs Research, however, were skeptical.

Clearly, given today’s cycle of high inflation, experts are instead speculating about the potentially inflationary impact of new global forces on measured inflation (official inflation statistics) – deglobalization, the green transition and AI.

Many argue that deglobalization and the green transition are structurally inflationary and likely to raise production costs and consumer prices. Again, our Research colleagues remain skeptical about the net impacts. Why? Because details matter; The form of government intervention plays an important role.

They point out that a large government push is probably needed for change to occur quickly enough to have a notable impact on inflation. And that push can come in the form of subsidies or taxes. So far, US policymakers have relied mostly on subsidies (which are easier to get through Congress).

While taxes are likely to raise prices, subsidies are likely to lower consumer prices when paid to producers who pass on the savings. The lower prices created by subsidies will look deflationary in the eyes of the official inflation figures. In reality, consumers are probably not any better off because they have to pay taxes to fund the subsidies, but the official statistics don't consider this.

With this complex web of factors in mind, let’s take a closer look at the forces of deglobalization, the green transition and AI and examine their potential impact on inflation.

Deglobalization

The effects of deglobalization on production/supply chains – including reshoring (moving back to the US), near-shoring (moving closer to home) and friend-shoring (moving to an ally country) – are usually thought of as inflationary, but so far, that isn’t the clear result.

The supply shocks and geopolitical risks of recent years have pushed American companies to think carefully about where they work and produce their goods. If companies decide to shift production to higher-cost countries, that could cause consumer prices to rise.

But the GS Research team found that instead of moving their production, US companies were mostly boosting their trade resilience by overstocking inventories and diversifying their foreign suppliers. This is likely because in a competitive market, it’s hard for companies to incur the large short-term costs of a major relocation unless their competitors do so too.

Interestingly, most of the reshoring so far has come in industries where the government offers large subsidies. And we’ve already talked about how subsidies can show up as deflationary in official statistics.

Deglobalization – Inflationary or deflationary? Balanced. Subsidized reshoring is likely to be mildly deflationary, while diversifying global sourcing looks to be modestly inflationary.

The green transition

The transition to greener energy could be inflationary if the government imposed carbon taxes or forced consumers and businesses to switch to more expensive clean energy sources. Instead, as with reshoring, Congress opted to provide encouragement by offering subsidies to producers (for example, through the Inflation Reduction Act), which should lower consumer prices.

There are also tax rebates for consumers, which could increase the retail prices they are willing to pay. Surprisingly though, several studies have found that tax rebates for hybrid and electric vehicles did not lead automakers to raise prices much. Instead, 80%-100% of subsidies were captured by consumers, making them mildly deflationary as well.

The green transition – Inflationary or deflationary? Subsidies and rebates might be mildly deflationary.

Artificial intelligence

So, what about AI? Many hope it can create the kind of tech-led productivity boom that helped keep inflation low in the late 1990s and early 2000s, but there are a few differences worth noting.

Much of the earlier productivity growth came from improvements in technology goods, like larger hard drives and faster CPUs. Their monetary value could easily be measured and incorporated into the official inflation statistics.

AI, in contrast, is likely to improve consumer goods and services in ways that are harder to put a dollar figure on, like creating a better digital assistant on a smartphone or enabling a better medical diagnosis. And inflation data may not reflect these improvements accurately.

AI may also lower production costs – the benefits of which could be passed on to consumers (i.e., lower prices). However, monopoly power might cause some of the cost savings to show up as higher profit margins for producers instead.

Artificial intelligence – Inflationary or deflationary? Could be deflationary, but results might not be fully captured because some effects may be hard to measure.

How to think about future inflation

Since there will be pressures on prices in both directions in coming years, it’s especially hard to predict the overall impact.

It’s also important to remember the Federal Reserve’s role in controlling inflation. If new trends put downward or upward pressure on inflation for a while, the Fed will likely step in to correct the course. Their actions can affect credit availability and the strength of the labor market, along with a host of fall-out effects on the economy and markets.

So, even if the new trends don’t prove to be as powerful as some think, they could still have meaningful short-term impacts. If you’re concerned about the impact of future inflation on your long-term financial picture, it’s best not to rely on broad assumptions but to watch the data carefully as it unfolds, just like the Fed.