Accelerating OER and Services Prices to Keep Inflation High

Link to PDF: “Accelerating OER and Services Prices to Keep Inflation High”

The attached paper “Accelerating OER and Services Prices to Keep Inflation High” by Mickey D. Levy was presented to the Shadow Open Market Committee on February 11, 2022. It describes how inflation has been driven by strong aggregate demand aggravated by supply constraints and argues that inflation will remain elevated in 2022-2023, far above the Federal Reserve’s forecasts. This will occur as an acceleration of services inflation will more than offset disinflation or even deflation of goods prices as supply constraints dissipate.

Three factors are identified that will drive up services inflation, which represents nearly two-thirds of both CPI and PCE inflation. First, the pipeline of monetary and fiscal stimulus will continue to generate strong growth in aggregate demand. Real interest rates will remain negative even as the Fed raises rates, and deficit spending authorization that has not yet been spent will continue to flow into the economy, and new government spending on infrastructure will provide an extra boost. Second, based on a vector auto-regression model developed by Berenberg economist Mahmoud Abu Ghzalah and Levy, owners’ equivalent rent (OER) and rental costs, which comprise shelter costs, the largest components of inflation, are forecast to accelerate to 5.6% and 6% respectively, and remain elevated based on the historical lags between home prices, rents, and measures of shelter inflation.

Third, accelerating services inflation is expected to be driven by strong product demand as services activity catches up to goods consumption as the economy normalizes, continued nominal wage increases, and rising operating costs. Rising nominal wages will be driven by very tight labor markets and the feedback of higher inflation and inflationary expectations on wages.

Mickey Levy, mickey.levy@berenberg-us.com

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