It’s still too soon to relax on inflation
On Wednesday, Federal Reserve Chair Jerome Powell explained the central bank’s current thinking on inflation in a speech at the Brookings Institution. The next day, with impeccable timing, October’s inflation figures turned out to be broadly consistent with his remarks. Inflation is coming under control, but the problem is far from solved; interest rates still need to go higher, but the pace of tightening can be eased a little.
The Fed’s next policy-rate decision will be announced on Dec. 14. Investors had already penciled in a 50 basis-point increase, down from the 75 basis points announced after each of the Fed’s four previous meetings. Powell’s remarks went along with this — and so did the slower-than-expected rise in the Fed’s preferred measure of core inflation. The increase in the price of personal consumption expenditures excluding food and energy was 0.2% in October, giving a year-onyear rise of 5.0%. That was a bit lower than private forecasters had predicted.
Yet, as Powell emphasized, it’s too soon to celebrate. Personal spending is still strong. Friday’s payroll data showed an unexpectedly fast rise in employment last month and the biggest increase in hourly pay since January. This raises doubts over whether demand is cooling as quickly as needed. Core PCE inflation of 5% is still far too high. And an arguably better measure of core prices (based on median PCE, which strips out the biggest fluctuations, not just those for food and energy) was up
5.7% in the year to October, only slightly down from the previous month.
All this suggests that the
Fed’s biggest concern can’t yet be ruled out: Without further tightening, inflation might settle at far too high a rate. The range for the current policy rate is 3.75% to 4%; add 50 basis points in December, and it will still be negative in real terms. The Fed has been tightening very rapidly by its own past standards, and monetary policy is now much less accommodative than in the spring, but the policy rate isn’t yet “restrictive” in the ordinary sense.
For that, a rate of 6% or more could turn out to be required something that investors have lately been betting against. The prospect of rates so high would revive fears of a hard landing for the economy, which in turn would lead to mounting pressure on the Fed to relax. One form of criticism is already easy to predict: Some well-respected economists argue that the Fed’s 2% inflation target is too low.
If this were reset to 3% or 4%, it’s argued, a gentler slowdown would do the job (and policy would be simpler to manage through the medium and longer term as well, because interest rates would reach the socalled zero lower bound less frequently).
Let’s hope this idea gains no further traction. Confidence in the central bank’s ability and determination to get inflation back down to 2% is one of its most powerful assets. Medium-term inflation expectations have edged up of late, but surprisingly little in view of the enormous current overshoot. That’s much to the Fed’s credit — and it’s making a very hard job a little less difficult.
Powell’s message that the central bank can’t relax and will do what it takes to control inflation is right. Before his job is done, that commitment might be tested more severely than anyone would like.
All this suggests that the Fed’s biggest concern can’t yet be ruled out: Without further tightening, inflation might settle at far too high a rate. The range for the current policy rate is 3.75% to 4%; add 50 basis points in December, and it will still be negative in real terms. The Fed has been tightening very rapidly by its own past standards, and monetary policy is now much less accommodative than in the spring, but the policy rate isn’t yet “restrictive” in the ordinary sense.