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Inflation has come down from historic highs, although not far enough to stop disrupting the economy.
This is the data from the data released yesterday. First, the good news: Prices rose at their slowest pace in nearly two years, after rising 5 percent in the 12 months that ended in March. The increase is still higher than the 2 percent annual rate that policymakers are trying to keep the economy humming — but down from last summer’s 9 percent peak.
The bad news is that other measures – particularly indicators that exclude food and energy prices, known as core inflation – tell a more mixed story. In the chart below, you can see that core inflation is more stable than overall inflation and, for that reason, is less susceptible to misinterpretation.
“We have passed peak inflation,” said my colleague Jeanna Smialek, who covers the Federal Reserve, America’s central bank. “But inflation is still quite stubborn.”
The mixed news suggests that the Fed’s latest measures have been able to tame inflation, but more action is needed to boost prices to sustainable levels. Today’s newsletter will break down the data and what the Fed will do next.
Mixed picture
There is an underlying story behind the numbers, from a few years ago. Flush with money from the Covid relief legislation and stuck at home during the pandemic, Americans are buying more things they can use at home. So the price of goods – physical goods such as furniture and appliances – will increase significantly in 2021.
As the economy recovers from the shock of Covid and people start going out again, consumer demand is shifting to services – things to do, like making a meal for you at a restaurant or flying you across the country. Prices are rising, especially in airlines, transportation and restaurants, as you can see in this chart:
This trend is what policy makers are seeing today. This shows that consumer demand is still very high – first chasing limited goods and now chasing limited services, leading to price increases.
There are some good signs for the outlook that inflation will fall again. The flood of cash received from the government during the pandemic has dried up, reducing consumer demand. The supply chain was largely spared the snarls of the previous Covid days. The shock to oil and gas prices from the Russian invasion of Ukraine has subsided. The Federal Reserve, in an effort to prevent more demand, raises interest rates to make borrowing more expensive.
But there are also some potentially bad signs. American consumers are still spending heavily, taking advantage of higher wages and savings accumulated during the pandemic. The cartel of oil-producing nations, OPEC, is cutting production to try to raise prices. Inflation that has been going on for a long time has been growing in the economy – making it harder to bring it down. “It’s not that inflation is going to go back and rise again, but we may not be able to eliminate what’s left,” Jeanna said.
Any
Going forward, policymakers will try to take a balanced approach to match the mixed story. The Federal Reserve is likely to take more measured steps than last year. The central bank regularly raises rates by half a point or more for most of 2022, but adopted a smaller quarter-point increase last month and is expected to repeat the move at its next meeting in May.
There is a risk that the Fed does too little and inflation remains, as will be the case in 2021. But there is also a risk that the Fed goes too far and does unnecessary damage to the economy, as explained in this newsletter earlier. A strong economy could lead to faster price increases. But a weak economy could put many people out of work. Policymakers try to find the sweet spot between these two extremes.
The latest inflation data shows that the country is getting there – that the end of rapid price increases may be in sight now. But the data is not clear enough to dismiss the mirage.
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