Chart of the Week: Maybe this time, the US economy might be lucky

For much of the past year, Fathom has been telling clients that historical precedent makes a US recession more or less inevitable. When US inflation has risen as dramatically as it did last year, peaking at a shade under 9% in June, policymakers have almost never brought it back to more comfortable levels without a recession. The last time they pulled off such a feat was in 1951. Why do disinflations prove so costly? This week’s chart offers some clues. As inflation moves towards double digits, it inevitably gets embedded into wages. This is the familiar wage-price spiral. To get consumer price inflation down you have to force wage inflation down. Typically a recession has been required to break that cycle, as our chart shows. The Fed’s previous approach has been to tighten until something snaps, and the economy enters recession: only then does wage inflation fall sharply. This pattern is particularly clear during the early 1980s, when Paul Volcker was Fed chair, but it is also clear to a degree in the mid-1970s, and the early 1990s. These were all run-of-the-mill, monetary policy-induced recessions. But this time, something is different. Wage inflation has already fallen sharply, and with it consumer price inflation, and yet nothing has broken – yet. As long as US wage inflation keeps moving steadily towards the 3.0%-3.5% range, the kind of rate that is compatible with a 2% inflation target, we believe the US stands a good chance of avoiding recession.

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