Despite recent signals that inflation may have finally started receding in the U.S., it may not yet be time to declare victory in the war against rising prices.
Last month, the latest inflation data came in much cooler than expected, with prices registering a 7.1% increase over the year prior. It marked U.S. inflation’s fifth consecutive monthly slowdown and a precipitous drop from its peak at 9.1% in June, as lower prices for used cars, electricity, and gasoline finally showed signs of pushing down inflationary pressures.
Combined with strong employment numbers, the Federal Reserve appears to be on the right path toward bringing inflation down without triggering a recession in the economy and a surge in unemployment.
Some high-profile economists including Nobel Prize-winner Paul Krugman and Goldman Sachs chief economist Jan Hatzius have even cited the positive signals as evidence inflation is past its peak and a recession-less soft landing is in store for the economy, providing an opportunity for the Fed to slow down or even reverse the aggressive series of interest rate hikes it has championed for the past year to bring down inflation.
But not every economist agrees inflation has been contained in the U.S., nor that the Fed should consider pausing its cycle of rate hikes just yet.
“If you see the indicators in the labor market and if you look at very sticky components of inflation like services inflation, I think it’s clear that we haven’t turned the corner yet on inflation,” Gita Gopinath, deputy managing director of the International Monetary Fund, said in an interview with the Financial Times published Thursday.
Gopinath cited the persevering strength of the U.S. labor market as a reason to be concerned about inflation’s staying power, adding that historically low unemployment numbers and a worker shortage could continue exacerbating wage increases and keep inflation uncomfortably elevated.
While investors and politicians have taken the recent dip in inflation as an opportunity to encourage Fed Chair Jerome Powell to consider slowing down the pace of rate increases, Gopinath and the IMF advised the opposite, urging the Fed to “stay the course” on its planned prescription of rate hikes to bring inflation down.
To pause or not to pause
After the Fed’s seven rate hikes in 2022 dragged down markets to historic lows, many have grown increasingly frustrated with Powell’s strategy.
Investors were the ones to fare the worst last year after rate hikes tanked the stock markets, while many economists have forecasted the hikes to spark a recession in the U.S. this year, but criticism towards Powell and the Fed has come from all corners of Congress too.
Democrats have criticized the central bank for playing with working Americans’ livelihoods by risking a massive unemployment surge, while Republicans have issued proposals to scale back the Fed’s system of regional banks, citing concerns over lacking accountability and accusing regional banks of inserting themselves into politically sensitive issues.
Powell is likely to come under even more pressure from his critics this year to adjust the Fed’s strategy as inflation shows signs of waning. Even some officials from within the Fed itself including San Francisco president Mary Daly and vice-chair Lael Brainard have recently suggested the time is near to reevaluate the speed and size of rate hikes.
Powell has so far remained staunchly committed to the planned strategy of rate hikes until the economy reaches its target inflation target of 2%, promising more increases for 2023, a policy the IMF’s Gopinath advised he stick to until inflation’s decline is clear for all to see.
Gopinath backed the Fed's goal of hitting a 5% benchmark rate this year, and said criticizing the Fed for overly tight monetary policy was a “hard” argument to make, given the lack of clear evidence so far that inflation is on a permanent decline.
The Fed should stay the course on rate rises until a “very definite, durable decline in inflation” is observed, Gopinath said, adding that it was important for the Fed to maintain a “restrictive monetary policy” until inflation begins coming down in wages and parts of the economy not related to food or energy items.
