Let’s hope not
Today’s inflation data showed continued rapid growth in the overall CPI, rising 9.1% year over year. A similar reading last month led to a large overreaction by many, including the Federal Reserve, who raised policy rates by 0.75%.
There is even less reason this time to overreact to a hot inflation reading. We all know that the main drivers of today’s large number is commodity prices (mostly energy and food), and we also know that many of these prices have fallen sharply in recent weeks.
But, the price declines are so-recent that they are not picked up in the June data being reported on today. It’s not totally-unlike the employment report released on March 3, 2020, that described labor market conditions in February 2020.
It was a great jobs report. And everybody knew that the perception of the US economy it fostered was completely obsolete – by the time the report came out, COVID-19’s effects were hammering the economy.
It’s obviously far from a perfect analogy. Even if, as expected, large commodity price declines (and expected declines in some goods prices) start pulling down overall inflation rates very shortly, this doesn’t mean the problem of inflation is completely over.
But it does highlight that economic conditions are changing rapidly, and many of the data conventions that guide economic commentary and analysis are poorly-positioned to recognize this.
For example, wage growth is showing clear signs of decelerating, and in recent months has already hit levels consistent with normal (ie, less than 3%) levels of inflation. But, the convention of focusing on year-over-year measures might miss that.
A similar story applies to what was once widely-agreed as the most important inflation gauge for the Fed – the core price index for personal consumption expenditures. It also has shown deceleration in more-recent months.
https://fred.stlouisfed.org/graph/?g=RHBy
Two extremely salient data releases for inflation’s path over the next year will come out in the days immediately *following* the next FOMC meeting (the ECI for 2022q2 and the PCE price data). The Fed should not undertake another 0.75% hike based on today’s data.
They have time to wait and see if recent signs of deceleration come to fruition. The risk of damaging the strong and welcome recovery from the pandemic recession is very high and many drivers of inflation may already be slowing.
Krugman agrees:
Agree with this thread — today’s hot inflation number is already out of date, not reflecting falling gasoline prices and other factors that have recently gone into reverse. But hard to imagine that the Fed won’t hike by 75 anyway
The good news is that I don’t think this matters much. The long-term rates that matter for the real economy much more dependent on how high Fed funds eventually goes than on the precise path. The question really is how the Fed reacts if/when the numbers improve
If it signals a more dovish turn if, as Josh and I both expect, underlying inflation looks better by the next FOMC meeting, not too much damage will have been done. Markets pricing in much slower inflation looking forward; if this starts to show in real data, we’ll be OK
Originally tweeted by Paul Krugman (@paulkrugman) on July 13, 2022.
Fingers crossed … oy.