The Fed Is Getting Less Sanguine About Inflation. Here's Why.
Consumer spending power and underlying price pressures are not yet ticking lower. That is worsening the perceived tradeoff between growth and inflation.
I wish there were a completely painless way to restore price stability. There isn't.
—Jerome Powell, December 14 2022 FOMC press conference
Federal Reserve officials are becoming increasingly convinced that prices will continue to rise faster than desired without a sharp economic slowdown. The latest projections of growth, unemployment, inflation, and interest rates “under appropriate monetary policy” imply that they believe that the cost of taming inflation has gotten worse compared to September.
While I hope that their pessimism is unwarranted—and that Fed officials will be nimble enough to adjust their policy if it needs to be recalibrated—their concerns are consistent with the latest data on underlying income growth as well as measures of underlying price pressures. Moreover, if we look at the inflation measures that Fed officials say they are focusing on, it is clear that there has been a persistent acceleration in price growth. While inflation in these sub-categories could slow on its own, there is no sign yet that this is happening.
The Disappointed Hopes of 2021
Last summer, Fed officials were incredibly optimistic about the U.S. economy in the years after the pandemic. By the end of 2023, they believed that American workers and businesses would be producing almost 3% more goods and services compared to what had been projected in the last pre-pandemic forecast “under appropriate monetary policy”. The price level would barely be any higher, and the unemployment rate would be lower.
Things have changed since then. Fed officials now believe that real U.S. gross domestic product at the end of 2023 will be 6% lower than what they had been projecting in June 2021, while the price level will be almost 7% higher. The unemployment rate consistent with “appropriate monetary policy” at the end of 2023 is now expected to be more than 1 percentage point higher than had been expected last summer.
Fed officials now believe that the U.S. economy is set to be 3.5% smaller—permanently—compared to what they were expecting at the end of 2019, while the price level will be at least 8% higher than the pre-pandemic baseline by the time inflation stabilizes sometime in 2026.