Why America can’t escape inflation worries 22/04/2024, 13:47

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Why America can’t

escape inflation
worries
The Federal Reserve sticks to its plans, despite an
uncertain situation

photograph: epa/shutterstock

Mar 20th
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2024 | washington, dc

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S ome hikers believe that the last mile is the

hardest: all the blisters and accumulated aches
slow progress at the very end. Others swear that it
is the easiest because the finishing line is in sight.
For the Federal Reserve, the last mile of its trek to
bring inflation back to its 2% target has been
simultaneously easy and hard. Easy in the sense
that the central bank has not budged on interest
rates for eight months, instead letting its previous
tightening do the work. Hard because the wait for
inflation to recede has felt rather long.

The slow easing of price pressures and America’s

continued economic vigour have fuelled debate
about whether the Fed might chart a more
aggressive course for the last mile of its anti-
inflation journey. Policymakers had telegraphed
that they would make three quarter-point rate cuts
this year. But since then some prominent measures
of inflation have seemingly got stuck at around 3-
4%, while the unemployment rate has remained
below 4%. So the big question heading into a
monetary-policy meeting that concluded on March
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Why America can’t escape inflation worries 22/04/2024, 13:47

monetary-policy meeting that concluded on March

20th was whether the Fed might pare its projection
to two cuts. In the end, the central bank (or, to be a
little more precise, the median voting member of
its rate-setting committee) opted to maintain its
outlook for three cuts in 2024, though it lowered its
projection for 2025 from four cuts to three.

An

chart: the economist

important gap in inflation measures helps explain

the Fed’s rationale for sticking with its plan for this
year. Much of the concern about the persistence of
inflation stems from recent readings of the
consumer price index. “Core” cpi, which strips out
volatile food and energy costs, decelerated
throughout much of 2022 and early 2023, but since
last June has picked up speed. In both January and
February it rose at a monthly clip of roughly 0.4%, a
rate which, if sustained for a full year, would lead to
annual inflation of about 5%—far too high for
comfort for the Fed. In such a scenario America’s
central bankers would be fretting not about cutting
rates but about whether to resume raising them.

Yet whereas investors and commentators tend to

emphasise the cpi, in no small part because it is
the first inflation data point each month, the
central bank’s focus is a separate gauge: the price
index for personal consumption expenditures,
which comes out several weeks later. Core pce
prices have been better behaved. Although they
heated up in January, their annualised pace over the
past half-year has been smack in line with the Fed’s
2% inflation target. This has helped give central
bankers the confidence that they can start
trimming rates relatively soon.

At a
press

chart: the economist

conference after its meeting Jerome Powell, the

Fed’s chairman, studiously avoided giving any
strong hints about when the central bank will make
its first cut. But the market—as implied by the price
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Why America can’t escape inflation worries 22/04/2024, 13:47

its first cut. But the market—as implied by the price

of rate-hedging contracts—expects that it will get
under way in June. And Mr Powell was generally
satisfied with price trends. “We continue to make
good progress in bringing inflation down,” he said.

What accounts for the cpi-pce divergence? The

cpi is more rigid, with its components adjusted
annually; the pce is in e!ect adjusted every month,
reflecting, for example, whether consumers
substitute cheaper apples for dearer oranges. Over
time that leads to slightly lower pce price growth.
Di!erent weightings have also had a big impact
this year. Housing makes up about a third of the
cpi basket but just 15% of the pce one, and
stubbornly high rents have kept the cpi elevated.
There are other di!erences, too. For instance,
airfares pushed up the cpi in February, based on
prices for a fixed set of flight routes. The pce,
which considers distances actually flown, has been
lower.

Neutral territory
Once inflation does come down, the Fed’s o"cials advertisement

face another debate. In an ideal world central

bankers would guide a full-employment, stable-
inflation economy to what is known as the neutral
rate of interest, the level at which monetary policy
is neither expansionary nor contractionary. In
reality, although there is no way of observing the
neutral rate the Fed still tries to aim for it, with its
policymakers writing down their estimates every
quarter. Since 2019 their median projection has, in
real terms, been 0.5% (ie, a Fed-funds rate of 2.5%
and a pce inflation rate of 2%).

That has changed, albeit pretty imperceptibly.

Narrowly, the Fed’s new median projection for
rates in the long run shifted up to 2.6%, implying a
real neutral rate of 0.6%. This may sound like a
puny, academic di!erence. But it lies at the core of
central-bank thinking about post-pandemic
growth, in particular whether o"cials believe that
rates should be higher on an ongoing basis in order
to avoid economic overheating, perhaps because of
rising productivity or excessive government
spending. They appear to be heading towards that
view, though Mr Powell demurred on drawing any
conclusions based on the upward creep in long-run
rates. The Fed still has to travel the last mile in its
fight against inflation. Even once the journey
comes to an end, though, a di"cult interest-rate
question will remain. ■

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This article appeared in the Finance & economics section of the print
edition under the headline "The last mile"

Finance & economics

March 23rd 2024

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Why America can’t escape inflation worries 22/04/2024, 13:47

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