Charts of the Week (July 14, 2023)

The Blue Chip growth consensus for 2023 Domestic factors are taking over from global factors as principal drivers of GDP growth in the world’s major economies. This is one of the messages from the latest Blue Chip survey of economic forecasters. For example, although the outlook for the US economy in 2023 has been revised up over the past two months, GDP forecasts for China and the euro area have been revised down. This decoupling contrasts with the last 18 months or so, when forecast revisions to the outlook for 2023 were far more synchronized in both an upwards and downwards direction (see chart 1 below).

The Blue Chip inflation consensus for 2023 This decoupling applies to the inflation outlook in 2023 as well. The Blue Chip consensus for CPI inflation in China, for example, has been lowered quite sharply over the last few months. That contrasts with some stability in the inflation outlook for the US and the euro area. It contrasts even more starkly, however, with the large upward revisions that have been made to inflation forecasts for the UK (see chart 2 below).

Energy prices and consumer confidence One of the key reasons for these fading global drivers of the economic outlook concerns energy prices. Negative supply shocks from the COVID pandemic and the war in Ukraine coupled with looser policy settings spawned big imbalances in key commodity markets in recent years, and most notably in the energy sector. The ripple effects from these imbalances for energy prices, broader inflation rates and for consumer confidence were profound (see chart 3 below). As these imbalances have unwound, however, these ripple effects have diminished leaving domestic growth and inflation drivers to now move into the ascendancy.

The UK labour market Notwithstanding a more troublesome inflation outlook for the UK, this week’s data offered welcome evidence of some loosening in the labour market. The unemployment rate rose from 3.8% to 4.0% in the three months to May, for example. In addition to this, vacancies continued to fall. That means that the vacancies to unemployment ratio – a good gauge of labour market dysfunction - has continued to normalise. This can be further illustrated via the Beveridge curve analysis shown in chart 4 below.

Estimates of trend GDP growth Key considerations – and uncertainties - for the calibration of monetary policy concern estimates of an economy’s potential GDP growth and r-star (the real short-term interest rate that’s expected to prevail when an economy is at full employment and inflation is stable). Some recently updated/resumed analysis from the Federal Reserve Bank of New York (FRBNY) sheds some light on this (see: Measuring the Natural Rate of Interest, FRBNY). A simple weighted aggregation of the FRBNY’s estimates for the US, euro area and Canada imply that there has been little-change in r-star in those economies in recent years. Indeed, latest estimates for Q1 2023 specifically suggest a weighted average level of around 0.7%, which is more or less in line with where it stood prior to the COVID pandemic (see chart 5 below).

Output gap estimates This does not mean, however, that central banks can relax. Calibrating monetary policy also requires assessing an economy’s underlying supply and demand imbalances and how these square with current inflation and central banks’ target levels. And at present, the FRBNY’s output gap estimates – which quantify that mismatch between demand and supply – suggest inflation could continue to climb in the period ahead (see chart 6 below). Putting that another way, a prolonged period of restrictive monetary policy may be required in order to keep economic growth below potential and, in doing so, close output gaps and quell inflationary pressures.