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NRF Economist Explains ‘Bad-News-Is-Good-News’ Inflation Strategy

While the Federal Reserve tries to contain inflation, tepid gross domestic product (GDP) growth could point to long-term economic improvement, National Retail Federation (NRF) chief economist Jack Kleinhenz wrote in the trade group’s monthly economic review on Tuesday.

Over the past year, the Federal Reserve has tried to lower inflation by raising interest rates, though “the effort has yet to reach its goal,” Kleinhenz said, noting the “formidable challenge” of “taming inflation without tipping the nation into a recession.” Current economic data, however, suggests the economy isn’t facing typical downturn, he said.

Slowing GDP growth could be key to controlling inflation, he said, noting how the economy “remained in gear” during the first quarter despite GDP expansion slowing to 1.1 percent—down 3 percent from the previous two quarters. According to Kleinhenz, many companies are clearing through inventory buildup instead of buying or producing new products.

That inventory overstock was a “huge drag” on what could have been a two-year record high of 2.6 percent GDP growth. Kleinhenz believes companies have been trying to reduce inventory to pre-pandemic levels because controlling their stock could prevent “a deeper and longer-lasting downturn” if one materializes.

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Meanwhile, consumer spending, which accounts for two-thirds of GDP and has “an outsized effect on the pace of the economy,” grew 6.5 percent during Q1 and 3.7 percent on an annual basis, up from growth of just 1 percent during the fourth quarter. According to NRF, disposable personal income saw annual growth of 8.4 percent, prompting households to spend more on durable goods (up 6.5 percent). “It is not surprising that Americans are still spending,” he said, noting that buying patterns are closely tied to income.

Kleinhenz also pointed to better-than-expected employment numbers despite high interest rates. The Employment Cost Index indicated that growth in private manufacturing wages and salaries decreased to 4.9 percent from 5.1 percent the quarter before, but it still hovered above the 3.5 percent rate required to be consistent with the Fed’s 2 percent inflation target. Heading into Q2, the U.S. added 253,000 jobs—up 4.4 percent from a year ago—while the 3.4 percent unemployment rate tied January for the lowest in more than 50 years. “The labor market remains tight and continues to be a surprise,” Kleinhenz said.

The Personal Consumption Expenditures Price Index, which the Fed monitor to track inflation, indicated a 4.9 percent rate in the first quarter, down from 5.7 percent in Q4 and better than 6.4 percent a year earlier. The Bureau of Labor Statistics’ Consumer Price Index (CPI) report for April indicated that U.S. urban consumers paid 0.4 percent more for goods and services month over month, up from a 0.1 percent increase in March. The index for all items, aside from food and energy, rose 0.4 percent in April, as it did in March. The index for apparel in particular rose 0.3 percent month over month, and 3.6 percent over the past 12 months. The Bureau’s data showed that the prices shoppers paid for men’s shorts saw the highest rate of growth at 2.2 percent, while prices for men’s suits, sport coats and outerwear, along with women’s outerwear, grew by 1.7 percent. Consumers spent 1.3 percent less on women’s dresses and 1 percent less on women’s underwear, swimwear, nightwear and accessories than they did in March.

The Fed authorized a 0.25-point interest rate increase last week, bringing the rate to 5.25 percent. Fed chair Jerome Powell said the Fed’s Open Market Committee hasn’t decided on its next move. Though “tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring and inflation,” he said, “the extent of these effects remains uncertain.”

“That is consistent with our views on the risks to the 2023 economic outlook,” Kleinhenz said. “But in the bad-news-is-good-news world of trying to control inflation, that may be exactly the result that is needed.

“The key is finding a way to control or manage the uncertainty,” he added.