How China’s economic rebound played a role in cooling US inflation

Tighter Fed monetary policy has undoubtedly contributed to the easing of US consumer price inflation
But the improvement in supply chain flows as China’s economy gained traction also played a part, showing how intertwined the two economies are

Neal Kimberley

Published: 1:30am, 18 Jan 2023

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It’s taken a while but after a succession of interest rate hikes in 2022 by the Federal Reserve, there are finally signs that US consumer price inflation (CPI) pressures are cooling. But what’s behind this? Tighter US monetary policy conditions have contributed but it would be going too far to say the Fed has played a blinder.

China has played a role and there’s a persuasive argument that an easing in global supply chain disruption last year, as China’s economy started to regain some traction, helped ease goods inflation in the United States in the second half of 2022, underscoring the continuing interconnectedness of the world’s two largest national economies.

Former Fed vice-chair Alan Blinder certainly thinks more than just higher US interest rates explain why the pace of US inflation increases has been easing. On January 6, in an opinion piece in The Wall Street Journal, Blinder wrote: “With one month remaining in 2022 (in terms of available data), [US] inflation in the second half of the year has run vastly lower than in the first half.”

Indeed, Blinder argues rightly that, from June through November 2022, US inflation “slowed to a crawl” if considered on a month-to-month basis.

Yet, Blinder adds, “hardly anyone has noticed this stunning development because of the near-universal concentration on price changes measured over 12-month periods, which are still 7.1 per cent for [headline US] CPI and 5.5 per cent [for the personal consumer expenditure measure of inflation that the Fed prefers to focus on]”.

In short, the pronounced month-to-month inflationary pressures that the United States experienced in the first half of last year are still skewing the year-on-year data even though the month-to-month rate of increase in US CPI in the last six months of 2022 fell away.

People shop for clothing at a Costco store in Monterey Park, California, last November. From June to November 2022, US inflation slowed dramatically on a month-to-month basis. Photo: AFP

At the time of writing, Blinder had no access to US CPI data for December. That data, released on January 12, reinforced his argument, showing that headline US CPI in December slowed to 6.5 per cent year on year from November’s 7.1 per cent reading. That was the smallest increase since October 2021.

Additionally, headline US CPI fell by 0.1 per cent month on month in December, the first negative figure since May 2020, when Covid-19 was spreading across the country.

As for the Fed, its first rate hike last year occurred in March, with year-on-year US CPI then peaking just a few months later in June, at 9.1 per cent. Either US inflation was remarkably susceptible to Fed rate hikes or something else was going on.

Blinder feels it “defies credulity to think that interest-rate hikes that started only in March could have cut inflation appreciably by July” but that “what did change dramatically [were] the supply bottlenecks”.

And that’s where China comes in. Admittedly, Shanghai was in lockdown from April to the start of June but data from the Port of Long Beach, a key entry point for Chinese goods into the US, illustrates how supply chain flows were nevertheless picking up.

Federal Reserve chair Jerome Powell speaks at a news conference at the William McChesney Martin Jr Building in Washington on December 14 when the central bank announced plans to raise its benchmark interest rate by half a percentage point, bringing it to the highest level in 15 years. Photo: EPA-EFELEE

Even as the Fed started to raise interest rates, the port recorded its busiest March on record, followed by its busiest ever April and prompting executive director Mario Cordero to say that the port was “preparing for a likely summertime surge as China recovers from an extended shutdown due to Covid-19”.

Cordero was correct, as record activity at the port for both June and July was recorded.

Given the appetite of US consumers for well-made, competitively priced Chinese goods, it seems fair to conclude that the improvement in the supply chain, as evidenced in the port activity data, fed into disinflationary impulses that were then reflected in much slower month to month US CPI rises in the second half of 2022, complementing the impact of tighter Fed monetary policy settings.

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But this also begs the question of what happens now that China has abandoned its zero-Covid policy. The faster the Chinese economy normalises, the greater its potential to increase exports to the US, assuming that ever-tighter US monetary policy doesn’t choke off American consumer demand.

As it is, another US rate rise should come on February 1, but the more it appears that US CPI pressures are trending lower, the more room the Fed has to pause tightening.

The Fed will take the credit if US inflation does continue to slow, but the partial normalisation of Chinese economic activity last year, alleviating pandemic-related global supply chain disruption, has also played a considerable role. The economies of China and the United States remain as intertwined as ever.

Neal Kimberley is a commentator on macroeconomics and financial markets. This is his last regular column for the Post