US inflation is moderating while a massive fiscal contraction is underway – recession looming

Yesterday (May 11, 2022), the US Bureau of Labor Statistics released the latest – Consumer Price Index Summary – April 2022 – which showed the monthly increase in the CPI to be 0.3 per cent, the lowest monthly increase since August 2021 and, as it happens, just about right on the average monthly growth rate from January 1947 and April 2022. The result suggests a tapering of price pressures. The Energy component fell by 2.7 per cent in April after spiking at 11 per cent in March. Further, the growth in food prices fell for the third consecutive month. All of this has nothing to do with the recent interest rises imposed on the economy by the US Federal Reserve. They were already in train and confirm the transitory nature of this period of price instability. The US Treasury Department also published its most recent fiscal statistics yesterday – Monthly Treasury Statement – for April 2022, which reports a staggering $US533,794 fiscal shift between April 2021 and April 2022 – the fiscal drag embodied in that shift is massive and calls into question the conduct of the US Federal Reserve – why did they think they needed to push the economy towards recession? Fiscal policy is already working in that direction!

The CPI data

The first graph shows the monthly All-Items US City Average CPI growth since January 2015 to April 2022 (CPI_U).

The graph shows that the CPI growth has risen to elevated levels since 2021 but is certainly not accelerating and is probably now in decline.

The next graph compares the trajectory of the All-Items series with the same series less the food and energy components.

It is obvious that the underlying inflation rate is much lower once we exclude the volatile items of food and energy.

Those volatile components are obviously linked because the rising oil prices feed into truck and delivery prices and other machinery used to produce food.

The next graph compares the All-Items series with the energy prices.

Energy prices fell 2.7 per cent in April and it is possible that oil prices have peaked as demand is falling.

Contrast the current experience with the next graph, which covers the period January 1970 to December 1985, a period in which two major oil price shocks occurred (marked by the red bars).

The first shock came in October 1973 as a result of the Arab OPEC members decision to increase the oil price by around 4 times. There were also some export bans to nations (for example, US, Japan, Western Europe) who were considered conspiring with Israel.

The inflation that followed started to recede in the latter part of that decade only to be hit by the second OPEC shock came with the – 1979 oil crisis – which was caused by a reduction in oil production associated with the Iranian Revolution.

A further shock to the oil price came soon after that as a result of the Iran-Iraqi War (beginning 1980).

It took the rest of the 1980s and the 1991 recession to fully expunge those inflationary pressures from the global economy.

The current situation has not become entrenched into a wage-price struggle nor in the long-term expectations as yet.

In the 1970s, both institutional forces pressured inflation upwards after the initial oil price shocks.

In the current period, real wages are falling as nominal wages growth lags well behind the temporary rise in the CPI. There is no sense that wages growth is pushing the inflation rate further ahead.

We know what the push factors are:

1. Supply disruptions in manufacturing and distribution – shipping, truck transport etc.

2. Workers continuing to become sick from Covid and being unable to work.

3. War in Ukraine.

4. OPEC anti-competitive profits push.

None of those push factors are very sensitive to interest rate changes.

And we keep hearing that business profitability is undermined by cost pressures emanating from wage rises.

Well, if that logic is valid, then surely the same impact will be felt from cost pressures emanating from interest rate rises.

And just as business uses its market power to pass the wage costs onto consumers, they will also pass on interest rate rises.

Thereby exacerbating the inflationary pressures.

The only way the interest rate rises will reduce inflation is if they are pushed to such high levels that the economy tanks into a deep recession and that stifles the capacity of the firms to push margins out.

But by then mass unemployment rises to high levels and we have a human tragedy on our hands.

Fiscal policy shifts

As noted in the Introduction, fiscal policy is contracting massively at the moment in the US.

On May 9, 2022, the US Congressional Budget Office released their – Monthly Budget Review: April 2022 – which showed that:

The federal budget deficit was $360 billion in the first seven months of fiscal year 2022 … That amount is about one-fifth of the $1.9 trillion shortfall recorded during the same period in 2021. Revenues were $843 billion (or 39 percent) higher and outlays were $729 billion (or 18 percent) lower than during the same period a year ago.

You might then be lured into thinking along these lines – there is still a fiscal deficit so the fiscal position of the government is still supporting the overall economy.

In one sense that is true.

There is still a net injection of government spending into the economy – the deficit.

But that doesn’t help us understand the situation very much.

We need context.

And context requires us to know what else is going on – with the private domestic sector and the external sector.

And it requires us to appreciate that it is the change in the fiscal position from period to period that is important in conditioning our view of what fiscal policy is up to.

On March 24, 2022, the US Bureau of Economic Analysis, which published National Accounts data and the Balance of Payments data, released the most recent Current Account data.

The release – U.S. Current-Account Deficit Widens in 2021 – told us that:

The U.S. current-account deficit, which reflects the combined balances on trade in goods and services and income flows between U.S. residents and residents of other countries, widened by $205.5 billion, or 33.4 percent, to $821.6 billion in 2021. The widening mostly reflected an expanded deficit on goods. The 2021 deficit was 3.6 percent of current-dollar gross domestic product, up from 2.9 percent in 2020.

So, in terms of expenditure flows, the external sector is draining an increasing amount of net spending from the domestic economy – thus undermining GDP growth increasingly.

The question then is with the fiscal balance fast heading towards balance at least, and the external sector draining 3.6 per cent worth of GDP out of the expenditure stream, what does that mean for the private domestic income and spending balance.

Well to fill that gap, the private domestic sector will have to increase its deficit and accumulate substantially more debt.

That is a particularly precarious prospect with current private debt at unsustainable levels.

And the rapidity of the fiscal shift is placing massive negative pressure on the spending system.

Next stop ?


And it would be completely self-inflicted by a failure to maintain responsible policy settings.

The next graph shows annual fiscal deficits ($US millions) calculated on a rolling monthly basis since 1985.

You can see that the rate of consolidation (contracting) in the current period is very rapid relative to say the GFC period.

The US government supported the economy for much longer during the GFC than during the current pandemic.

I fear the pace of consolidation is too fast at present.

The Monthly Treasury Statement (linked to above) for April 2022 shows a massive increase in revenue to the US federal government and only a modest rise in outlays (mostly due to price increases).

The fiscal shift in April was of the order of $US533,794 million, which in relative terms represents a very substantial withdrawal of expenditure from the system.

The lunacy of all this is that as the US government increases support for Ukraine, they are diverting spending from other areas such as education, chile care, health care and climate remediation.

Those areas were the basis of the president’s domestic agenda but they have fallen into the trap of thinking there is only so many US dollars available, which introduces the whole diversion mania.

The results will be fairly clear – a reduction in well-being for the US citizens, particularly low income recipients.


I had hoped when Jerome Powell made the August 2020 statement that suggested they were breaking out of the NAIRU mindset that things might change.

I wrote about that in this blog post – US Federal Reserve statement signals a new phase in the paradigm shift in macroeconomics (August 31, 2020).

However, I was wrong and policy makers in the US seem hell bent on bringing on a recession as part of a futile fight against inflationary pressures which are already moderating.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.