Inflation Has Eased, But Economists Are Still Worried

Inflation is starting to ease substantially for the American consumer. Gas is cheaper, eggs are roughly half what they did in January and prices are no longer rising as quickly across a wide range of products.

But at least one person hasn't expressed relief yet: Jerome H. Powell, chairman of the Federal Reserve.

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

But Mr Powell emphasized that it was too soon to declare victory in the battle against rapid price increases.

The reason: While cheaper fuel and slower adjustment of grocery prices have helped overall inflation come down from last summer's four-decade peak, food and fuel costs are likely to spike a lot. It obscures the underlying trend. And “core” inflation measures that strip away food and fuel are showing surprising resilience, as purchases ranging from dental care and hairdressing to education and auto insurance continue to rise rapidly in price.

Last week, Fed officials sharply raised their estimates of how high core inflation will be by the end of 2023. They now see it at 3.9 percent, higher than the 3.6 percent they predicted in March and nearly double the inflation target. their 2 percent.

In short, the economic picture is being played on a separate screen. While the sharpest price hikes appear to be over for consumers—a relief to many, and a development that President Biden and his advisers have celebrated—Fed policymakers and many outside economists see continuing reason to be concerned. Between the subtle signs that inflation is holding and the surprising resilience of the American economy, they believe central bankers may need to do more to cool growth and rein in demand to prevent the unusual price increases from becoming permanent.

“Big picture: We are making progress, but progress has been slower than expected,” said Kristin J. Forbes, an economist with the Massachusetts Institute of Technology and a former Bank of England policy maker. “Inflation has been somewhat more stubborn than we expected.”

Last week's new Consumer Price Index inflation report showed that inflation continued to slow sharply overall in May. That measure helps incorporate the Fed's preferred measure, the Personal Consumption Expenditure index, which it uses to determine its 2 percent target. The new PCE figures will be released on June 30.

White House officials, who have spent months on the defensive about the role of pandemic spending under Biden in fueling demand and rising prices, have greeted the recent cooling in inflation with enthusiasm.

“We've seen a huge drop in inflation, more than 50 percent,” Lael Brainard, director of the White House's National Economic Council, said in an interview. He added that the current inflation trajectory offers reason for optimism that inflation can return to normal soon enough as the economy slows, and expressed hope that crushing it would not require a huge spike in unemployment—something that has historically accompanied the Fed's campaigns. to deal with inflation.

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

But many economists are less optimistic. That's partly because most of the factors that have helped inflation fall so far have been widely anticipated, a sort of low-hanging fruit of disinflation.

Supply chains were shaken by the pandemic and have since recovered, allowing increases in the price of goods to slow. The surge in oil prices associated with the war in Ukraine has faded.

And there may be more to come: Rent is soaring starting in 2021 as people move out on their own or move out in the middle of a pandemic. They have since cooled off as landlords found that tenant demand was not strong enough to bear rising prices, and moderation has slowly baked into official inflation data.

What remains is a relatively rapid increase in prices in services outside of housing. That's a broad category, and includes purchases that tend to be labor intensive, such as hospital care, school fees, and sports tickets. Those prices tend to rise as wages increase, both because employers are trying to cover their higher costs and because consumers who earn more have the ability to pay more without retreating.

“Big action is behind us,” said Olivier Blanchard, a former International Monetary Fund chief economist now at the Peterson Institute. “What's left is the 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,” Powell said in congressional testimony on Wednesday, after noting that unemployment remained very low.

There are early signs that a slowdown in the labor market is under way. The Labor Cost Index measure of wages, which the Fed closely monitors, on a hike much faster than before the pandemic but has slowed from its peak in mid-2022. Measures from average hourly earnings has dropped even more prominently. And jobless claims have increased in recent weeks.

But hiring remains strong, and the unemployment rate is low — which is why economists are trying to figure out if the economy has cooled down enough to guarantee that inflation will return to full normalcy.

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

Even so, he's racking up credit card debt because of higher inflation and because he and his family are spending more money than before the pandemic. They've been to Disneyland twice in the last six months and eat out more often.

“It's about: you only live once,” he explains.

He says he feels fine spending beyond his budget, because he bought the house right at the start of the pandemic and now has about $100,000 in equity. In fact, he's not even that worried about inflation these days – he's been far more prominent when gas prices are rising rapidly.

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

Fed officials are not yet comfortable, and they may do more to tame rising prices. Officials predicted last week that 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 since 2000.

Investors doubt that will happen. Given the recent cooling in inflation and signs that the job market is cracking, they expect one more rate increase in July – and then an immediate rate cut early next year. But if that bet is wrong, the next phase of the war on inflation could be even more painful.

As higher borrowing costs encourage both consumers and companies to back off, it is hoped that this will lead to fewer hiring and fewer job opportunities for people like Mr. Scarbrough. The slowdown may put some people out of work altogether.

Fed policy makers predict that unemployment will jump to 4.5 percent by the end of next year – up slightly from 3.7 percent now, but historically quite low. But Mr. Blanchard thinks the unemployment rate may need to be increased by a percentage point “and maybe more.”

Jason Furman, a Harvard economist, said he thinks the unemployment rate could be even higher. While this was not his forecast, he said that in a bad scenario it would “probably” take around 10 percent unemployment for inflation to return to normal. That's how high unemployment soared to its worst point in the 2009 recession, and inflation fell by about two percentage points, he said.

In any case, Furman cautioned against jumping to premature conclusions about the path forward for inflation based on progress so far.

“People are too premature to continue declaring victory over inflation,” he said.