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The Fed and Inflation

On Tuesday, presidents of regional Federal Reserve Banks went into beast mode on fighting inflation. Per Bloomberg, Loretta Mester (president, Cleveland Federal Reserve Bank) said she “would need to see ‘compelling evidence’ that inflation is retreating, including several months of declining readings, before she could conclude that inflation has peaked. ‘I will need to see several months of sustained downward monthly readings of inflation. I have not seen that yet.’”

In a separate Bloomberg story, Charles Evans (Chicago Federal Reserve Bank) said “policy makers are ‘probably at least a couple of reports away’ from seeing the kind of improvement in the inflation data that would reinforce the notion that they are on the right track with monetary tightening” and Mary Daly (San Francisco) argued ‘‘‘we are still resolute and completely united’ in the objective of getting inflation down around the 2% inflation target.”

Meanwhile, in a parallel universe, the White House and press sparred over whether the United States is already in a recession and policymakers on Capitol Hill began to lobby for the Fed to stop and reverse course. St. Louis Fed President Jame Bullard disagreed, arguing “the US economy is unlikely to experience a recession, and that the Fed ‘may be able to disinflate in an orderly manner and achieve a relatively soft landing,’ where it slows inflation without sparking a contraction.”

What is going on?

In large part, it depends upon what data is being discussed. Those worried about recession point to the Bureau of Economic Analysis’ two consecutive quarterly reports of declining gross domestic product (GDP). The Fed is well aware of the GDP data but is convinced that the only route to sustained high employment and sustained GDP growth is to get inflation under control. And in its view, inflation is far from under control.

To see why, consider the performance in 2022 of its preferred measure of inflation: the price index for personal consumption expenditures.

2022

JAN

FEB

MAR

APR

MAY

JUN

Personal consumption expenditures (PCE)

6.0%

6.3%

6.6%

6.3%

6.3%

6.8%

Goods

8.8%

9.5%

10.6%

9.5%

9.6%

10.4%

    Durable goods

11.5%

11.0%

10.1%

8.4%

6.6%

6.1%

    Nondurable goods

7.2%

8.6%

10.8%

10.1%

11.3%

13.0%

Services

4.5%

4.6%

4.6%

4.6%

4.6%

4.9%

Addenda:
    PCE excluding food and energy

5.1%

5.3%

5.2%

4.9%

4.7%

4.8%

    Food

6.6%

8.0%

9.2%

10.0%

11.0%

11.2%

    Energy goods and services

26.0%

25.8%

34.0%

30.4%

35.6%

43.5%

    Market-based PCE

5.8%

6.2%

6.8%

6.5%

6.7%

7.3%

    Market-based PCE excluding food and energy

4.8%

5.1%

5.1%

4.9%

4.8%

5.1%

 

The most important thing to notice is that between May and June, every measure of PCE inflation accelerated. Accordingly, even though June closed out a second quarter that displayed a weak GDP report, the jump in inflation has sufficiently alarmed the Fed to deliver a hawkish message on the future of rate increases and financial tightening.

All eyes now turn to Friday’s report on employment in July. If the Bureau of Labor Statistics delivers a weak report, expect the volume on the debate to reach a Spinal-Tap-like 11.

 

Disclaimer

Fact of the Day

Together, the CHIPS and Science Act and the Inflation Reduction Act would increase the deficit by more than $10 billion per year from 2024–2027.