Why the Fed Is Still Raising Rates
The inflation and income data are not yet in a place where officials are comfortable.
“The disinflationary process has started,” Jerome Powell finally declared during Wednesday’s press conference—more than six months after inflation had already begun to decelerate. Yet Federal Reserve officials remain unconvinced that they have done enough to force spending down to match the economy’s productive capacity.1 In additioning to lifting short-term interest rates this week, they reaffirmed that “ongoing increases” would likely be necessary “to return inflation to 2 percent over time.”
The most straightforward explanation is that the progress we have seen so far only reflects the reversal of temporary factors. That is worth a lot, especially when looking at the broadest measures of inflation, but it is also not enough for Fed officials to feel confident that they are on track to get back to their 2% yearly goal. If excessive price increases were “transitory” on the way up, then they are also “transitory” on the way down. Monthly data suggest that the price impact of normalization in the production, distribution, and demand for manufactured goods may already have peaked.
What follows is a collection of charts focused on the latest numbers on the Fed’s preferred measure of inflation (PCE), composition-adjusted worker pay (ECI), and job churn (JOLTS). The links in the previous paragraph have more text explaining my thinking.
No Progress on Underlying Inflation (Yet)
Fed officials have repeatedly said that they are now focusing on PCE services prices excluding services and housing. This is a relatively broad swathe of the economy that should be relatively—although not completely—shielded from idiosyncratic forces and should therefore represent underlying inflationary conditions. This is how things look as of December (latest data).