December used to be a month that allowed time to unwind and reflect. The pace of news would slow, trading would ebb and the most challenging thing facing office workers was the annual purge of unneeded files. Companies would throw lavish holiday parties, the stories from which would form the core of committee discussions during the latter weeks of the year.
Times have changed, in more ways than one. This December has been especially hectic, with the transition in Brexit negotiations, U.S. tax reform debate and Bitcoin setting new highs every few minutes. Still, we’ve tried to pull ourselves away from current events to identify the most significant economic themes of 2017.
Paucity of Pricing Power
Economics 101 is pretty clear on one point: if demand accelerates, prices should rise. This year, however, that relationship was turned on its head. Despite accelerating expansion in many countries, inflation remains muted. (Great Britain is the exception, with Brexit exacting a toll on the value of the pound.)
There are many theories that attempt to explain this apparent conundrum. In her final press conference this week, Federal Reserve Chair Janet Yellen suggested that most of inflation’s retreat has been due to temporary factors. Among them was the re-benchmarking of prices for cellular telephone service and prescriptions, which had a pronounced impact this spring. However, the global nature of disinflation suggests that more than measurement issues may be at play.
Automation has been thrown out as another factor holding prices back. Few would disagree that computers and machines continue to advance efficiency, and new developments in artificial intelligence promise more in the years ahead. But the rather abrupt retreat of inflation would suggest a sudden impact, and technology usually exerts its influence gradually over time.
Automation of another kind is likely having a prominent effect. The impact of online merchants and the proliferation of online information have given global consumers extra leverage. Known in some quarters as “the Amazon effect,” this phenomenon has driven goods prices down. But service prices are more insulated from online disruption, and comprise a significant fraction of inflation indexes. And the Amazon effect may be a one-time change in structure whose effect on prices may fade over time.
Finally, the failure of wage growth to respond to low levels of joblessness in many nations has been a puzzle. Full employment has arguably been reached in the United States, Great Britain, Germany and Japan; but rates of pay increase in those countries have barely budged since 2014. Sluggish productivity growth, low inflation expectations (which causes wage demands to moderate) and corporate resourcefulness have combined to produce this outcome.
When will transitory factors fade? Will workers become emboldened? Will capacity become a constraint? Markets and central bankers will be following these narratives very closely in 2018.