Is It Too Early To Declare “Mission Accomplished” on Inflation?
Is It Too Early To Declare “Mission Accomplished” on Inflation?
Today’s data release on inflation and consumer spending, visualized on ZipRecruiter’s Economic Research website HERE, is the picture of a soft landing.
Personal income and consumer spending both rose at a rate of 0.7% in December, well above the expected 0.5% pace. Incomes were boosted by robust wage growth and rising asset returns, which have expanded Americans’ real disposable personal income—that is, income after taxes and inflation—4.2% over the past year.
The strong data comes on the heels of an equally strong GDP report yesterday, which showed that real gross domestic product increased at an annualized rate of 3.3% in the fourth quarter of 2023, well above the consensus expectation of 2.0%.
At the same time that the economy has grown robustly, inflation has fallen substantially. Consumer prices, as measured by the Personal Consumption Expenditures Price Index (PCE), have risen at a mere 0.5% annualized pace over the past quarter, well below the Federal Reserve’s target of 2%. Year-over-year PCE inflation fell to 2.6% in December from 3.4% in September, and core PCE inflation has fallen to 2.9% from 3.6%. If the recent pace of inflation is sustained, the year-over-year figure could soon fall below 2%.
Some observers (see one example here) have interpreted strong data on GDP and consumer spending as a sign that the Federal Reserve has no need to cut interest rates. Some have gone so far as to suggest that any rate cuts that take place in the coming months must clearly be driven by the political motivation to boost the chances of President Joe Biden in the upcoming general election.
But there is a strong economic case for declaring victory on inflation and starting to cut rates sooner rather than later.
The yield curve is still inverted, typically a sign of elevated recession risk, and leading economic indicators continue to deteriorate. Hiring has fallen to the lowest rate since 2014 outside of the pandemic, and job growth has become unusually narrowly concentrated in just three sectors: healthcare, the government, and leisure and hospitality.
Over $800B in deposits have left banks since the Federal reserve started raising interest rates, banks are sitting on large losses, and bank stocks recently reached an all-time low relative to the S&P 500 index. The housing market is in a deep freeze.
Arguably, gradual cuts to the federal funds rate would be a prudent way to balance risks at a time when inflation is at target, labor demand is cooling and narrowing, the financial system remains riddled with risks, and monetary policy operates with a lag. Waiting much longer risks moving too late.
Torsten Slok, Chief Economist at Apollo Global Management, points out that the Taylor Rule, a benchmark for monetary policy, currently signals that the Federal Funds rate should be 4.5% not 5.5%, where it currently sits. In that context, a rate cut would be an acknowledgement that the risk of the economy over-cooling is now at least as great as the risk of overheating, if not greater.
