The Fed’s favored personal consumption expenditures price index (PCE) has been on a sharp downward trend since June 2022 when it reached its 7 percent inflation high. Both its overall headline indicator (blue line) and core index without gas and energy prices (redline) are now rising in the 4 percent range.
A leading business economist that I like says inflation could plunge below the Fed’s 2 percent inflation target sometime next year. And that would mean a recession, so the Fed should begin to lower interest rates later this year.
“The forces that drove up inflation since the onset of the Covid pandemic are reversing rapidly,” said Ian Shepherdson, chief economist at Pantheon Economics, in a recent Barron’s article. “Over the next year, both the headline and core rates—the latter excludes food and energy prices—will drop sharply. By the end of 2024, inflation is likely to be below the Federal Reserve’s 2% target, and policy makers will be trying to stop it falling too far.”
This happened before under Fed Chair Alan Greenspan when the Fed’s prolonged rate hikes busted the housing bubble in 2007 and precipitated the Great Recession.
The inflation rate then sank below 2 percent for a prolonged period, which required Greenspan’s successor as Fed Chair, Ben Bernanke, to begin the various Quantitative Easing programs that pumped excess dollars into the economy to begin a slow recovery.
The main cause of inflation has been the supply shortages due to worldwide shutdowns from the COVID-19 pandemic. We know what happened to inflate grain and oil prices with the Ukraine War. But auto prices also skyrocketed with the shortage of chip supplies that are in all new cars.
Residential rents also soared, as work-from-home use also increased during and after the pandemic. Now rents are also returning to more normal levels.
To make his point, Shepherdson states, “Almost all of the eightfold increase in global container shipping costs has reversed, and domestic shipping costs also are falling rapidly. Semiconductor supply is back to normal, more or less, so vehicle production in April was higher than before the pandemic. About a third of the increase in auto dealers’ margins already has reversed.”
The labor market is the other shoe about to drop. The unemployment rate rose from 3.4 percent to 3.7 percent in May, with 339,000 new nonfarm payroll jobs created. This was because there are more workers in the workforce now than before the pandemic, which will slow the wage increases, another part of the inflation picture.
Most of the major economic indicators are either flat or declining, so now would be a good time for the Fed to anticipate what will happen next—a growing surplus of supplies as countries ramp up production that will further depress prices—rather than wait too long to react to changes as it did under Greenspan and during the pandemic.
It would be nice if the Fed allowed employees to keep their higher wages by not seeing rising wages in a tight labor market as the main cause of inflation. It would alleviate the record income inequality—the worst in developed countries—which in turn would help to calm the red state-blue state partisan divide, among other benefits.
We now have both hot and cold wars to win, so there’s no good reason to induce another recession.
Harlan Green © 2023
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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