A Message for the Federal Reserve in the New Inflation Data

What a difference a year makes. This time twelve months ago, the cost of gasoline was soaring, the prices of many other items were rising sharply as well, and Republicans were gleefully trumpeting “Bidenflation.” Now things are moving firmly in the other direction. When the Consumer Price Index for December was released on Thursday morning, it showed the headline rate of inflation dipping to 6.5 per cent, from 7.1 per cent the previous month. Since peaking at 9.1 per cent in June, the rate has fallen for six months in a row. And other details from the C.P.I. report are even more encouraging.

The headline rate of inflation is an annual figure: it shows how much prices rose between December, 2021, and December, 2022. To gauge more recent trends, it is also useful to look at changes over one month or three months, although these numbers should be viewed cautiously. Thanks largely to a sharp drop in the cost of energy, including gasoline, over-all prices didn’t rise at all in the last month: they fell by 0.1 per cent. To be sure, that’s a small change, but it represented the first monthly decline in prices since April, 2020, near the start of the coronavirus pandemic.

If you look at the past three months, the attenuation in pricing pressures doesn’t look quite as striking, but it’s still evident. In the period from October to December, the annualized rate of inflation was about two per cent. As Joe Biden pointed out in an appearance at the White House, that’s compared with more than ten per cent in the first three months of last year.

However you look at the figures, the over-all rate of inflation has come down appreciably as gas prices have fallen and pandemic-related problems with the global supply chain have eased. But what about “core” inflation, which strips out the prices of volatile items, such as food and energy, and which policymakers monitor closely? That metric also shows inflation declining from 6.6 per cent in September to 5.7 per cent in December. And, if you restrict your attention to the most recent three months, the fall in core inflation is quite dramatic—all the way down to 3.1 per cent on an annualized basis. “That is some seriously good news,” Julia Coronado, a former Federal Reserve economist who is president of the advisory firm MacroPolicy Perspectives, wrote on Twitter.

Some other commentators were more guarded, but they, too, acknowledged the downward trend. “The latest datapoint closes the books on 2022 and signals that meaningful progress in the U.S. economy’s fight against elevated inflation was made in the closing months of the year,” Matt Colyar, an economist at Moody’s Analytics, said in a statement. Biden, while acknowledging that “we still have more work to do,” was perfectly justified in declaring, “the data is clear: Even though inflation is high in major economies around the world, it is coming down in America month after month.”

Actually, because of a quirk in the way that the government treats the costs of housing, inflation may well be decreasing faster than the C.P.I. report indicated. One of the less encouraging takeaways from the report is that the price of shelter, which includes rents and lodging away from home, increased by 0.8 per cent last month, and by seven per cent over the previous twelve months. Since housing costs make up about a third of the entire C.P.I., this jump had a big impact on the over-all figures, particularly for core inflation, which rose 0.3 per cent in December. Indeed, the report noted that the “shelter index was the dominant factor in the monthly increase in the index for all items less food and energy.”

The issue, one widely acknowledged among economists, is that the C.P.I.’s measure of housing costs lags behind what is happening in the actual housing market, where rising interest rates have put an end to the boom that emerged during the first two years of the pandemic. Even as the C.P.I. shows the costs of shelter still rising, private-sector measures show the opposite. The widely followed S. & P. CoreLogic Case-Shiller Home Price Index has been dropping since July. And, according to Zillow, asking rents across the country fell in both October and November. (Figures for December aren’t available yet.)

This wading through the weeds has two important implications. If the C.P.I. reflected private-sector estimates of rents, the official estimates of headline and core inflation would now be lower. And, as the C.P.I. catches up with the private-sector data, there will be further downward pressure on the official figures. “Rising rents have been one of the drivers of inflation, so a rapid reversal would be a big deal,” Ian Shepherdson, the chief economist at Pantheon Macroeconomics, told me.

Will all this be enough to persuade Jerome Powell and his colleagues at the Federal Reserve to rethink their inflation-fighting strategy—and to prevent the Fed-induced recession that many economists have predicted later this year? Having already signalled another interest-rate hike next month, Powell et al. will almost certainly follow through with it, lifting the federal funds rate by another quarter point, to above 4.5 per cent. But they now have a lot to consider. In 2020 and 2021, as inflation spiked, they arguably failed to react quickly enough. With price pressures now easing, they will need to guard against moving too slowly again. ♦