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Inflation has moderated, but economists remain concerned

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Inflation is beginning to weaken in a meaningful way for American consumers. Gas is cheaper, eggs cost about half as much as in January, and prices for a wide range of products are no longer rising as fast.

But at least one person has yet to express relief: Jerome H. Powell, chairman of the Federal Reserve System.

The Fed has spent the past 15 months locked in an aggressive war on inflation, raising interest rates above 5 percent in an effort to bring price growth back to a more normal pace. Last week, its officials announced they were skipping a rate hike in June, giving themselves more time to see how the changes already enacted play out across the economy.

But Mr Powell stressed that it was too early to declare victory in the fight against rapid price rises.

The reason: While cheaper gas and slower food price adjustments helped overall inflation fall from its four-decade high last summer, food and fuel costs tend to bounce around a lot. This covers the underlying trends. And the measure of “core” inflation, which strips out food and fuel, is showing surprising resilience as prices for a range of purchases from dental care and hairdressing to education and car insurance rise rapidly.

Last week, Fed officials sharply upgraded their forecast for how high core inflation will be at the end of 2023. They now see it at 3.9 percent, up from the 3.6 percent they forecast in March and nearly double their 2 percent inflation target.

In short, the economic picture takes place on a kind of split screen. While the steepest rate hikes appear to be behind us for consumers — a relief for many and a development that President Biden and his advisers have celebrated — Fed policymakers and many outside economists see lingering reasons for concern. Between subtle signs that inflation may be sticking around and the surprising resilience of the U.S. economy, they believe central bankers may need to do more to cool growth and rein in demand to prevent unusually high price increases from becoming permanent.

“The big picture: We’re making progress, but progress is slower than expected,” said Kristin J. Forbes, an economist at the Massachusetts Institute of Technology and a former Bank of England policymaker. “Inflation is somewhat more stubborn than we had hoped.”

Freshly Consumer Price Index last week’s inflation report showed that overall inflation continued to slow sharply in May. The measure helps feed into the Fed’s preferred measure, the personal consumption expenditure index, which the Fed uses to define its 2 percent target. Fresh PCE numbers will be released on June 30.

White House officials, who have spent months on the defensive about the role that pandemic spending under Mr. Biden has played in boosting demand and rising prices, welcomed the recent cooling in inflation with enthusiasm.

“We’ve seen a very large reduction in inflation, more than 50 percent,” Lael Brainard, director of the White House National Economic Council, said in an interview. She added that the current trajectory of inflation offers reasons for optimism that it could return to normal fairly quickly as the economy slows, and expressed hope that crushing it would not necessarily require a big jump in unemployment — something that has historically accompanied Fed campaigns. fight inflation.

“The employment picture is very sustainable,” she said.

But many economists are less optimistic. Partly because most of the factors that have helped inflation so far have been widely expected to be the low-hanging fruit of disinflation.

Supply chains were battered by the pandemic and have since recovered, allowing commodity price growth to slow. The surge in oil prices associated with the war in Ukraine has faded.

And there may be more to come: Rents have soared since 2021 as people moved out or relocated themselves during the pandemic. They have since cooled as landlords find that tenant demand is not strong enough to support ever-higher prices, and the easing is slowly being reflected in official inflation figures.

Relatively rapid growth in prices for services outside of housing continues. This is a broad category and includes purchases that tend to be labor-intensive, such as hospital care, school fees and sports tickets. These prices tend to rise when wages rise, both because employers struggle to cover their higher costs and because consumers who earn more have the ability to pay more without having to pull back.

“The big event is behind us,” said Olivier Blanchard, a former chief economist at the International Monetary Fund who is now at the Peterson Institute. “What remains is pressure on wages.”

“We are very far from our inflation target of 2 percent, and we are very focused on getting back to 2 percent,” Mr. Powell said during congressional testimony on Wednesday. He later added that “today’s situation is unusual in that we are actually exceeding the maximum employment target, but we are far from hitting the inflation target.

There are early signs that the labor market is slowing. The labor cost index, closely watched by the Fed, is climbing much faster than before the pandemic, but has slowed since its peak in mid-2022. Rate average hourly earnings dropped even more significantly. And jobless claims have been rising in recent weeks.

But hiring has remained strong and the unemployment rate low — which is why economists are trying to figure out whether the economy is cooling enough to warrant inflation returning fully to normal.

Cylus Scarbrough, 42, has witnessed both features of today’s economy: rapid wage growth and rapid inflation. Mr. Scarbrough works as an analyst for a homebuilder in Sacramento and said his skills are so high that he could get a new job quickly if he wanted to. He got a 33 percent raise when he joined the company two years ago, and his salary has grown even more since then.

Still, he runs up credit card debt because of higher inflation and because he and his family are spending more than they used to before the pandemic. They have gone to Disneyland twice in the past six months and are eating out more regularly.

“It’s something about: You only live once,” he explained.

He said he feels good about spending beyond his budget because he bought a home right at the start of the pandemic and now has about $100,000 in equity. In fact, he doesn’t worry that much about inflation these days – it was much more important to him when gas prices were rising rapidly.

“That was the time when I really felt like inflation was eating away at our budget,” Mr. Scarbrough said. “I feel more comfortable with it now. I don’t think about it every day.”

Fed officials are not yet satisfied and may do more to tame rising prices. Officials last week predicted they would raise interest rates to 5.6 percent this year, making two more quarter-point rate moves that would push rates to their highest level since 2000.

Investors doubt that will happen. Given the recent cooling of inflation and signs that the labor market is starting to crack, they expect another rate hike in July – and then a full rate cut early next year. But if that bet is wrong, the next phase of the fight against inflation could be more painful.

As higher borrowing costs force consumers and businesses to pull back, they are expected to translate into less hiring and fewer job opportunities for people like Mr Scarbrough. The slowdown can put some people out of work altogether.

Fed policymakers estimate that unemployment will jump to 4.5 percent by the end of next year — up slightly from the current 3.7 percent, but still quite historically low. But Mr Blanchard thinks the unemployment rate may need to rise by one percentage point “and probably more”.

Jason Furman, an economist at Harvard, said he thought the unemployment rate could go even higher. While not his forecast, he said it was “possible” in a worst-case scenario that 10 percent unemployment would be needed to fully return inflation to normal. That high unemployment jumped at the worst of the recession in 2009, and inflation fell by about two percentage points, he noted.

In any case, Mr. Furman cautioned against jumping to conclusions about future inflation trends based on past progress.

“People were so insanely premature to continue to declare victory over inflation,” he said.

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