Ch19: Unemployment and Inflation – HubbardOBrienEconomics.com Blog

Inflation Cools Slightly in Latest CPI Report

Inflation was running higher than expected during the first three months of 2024, indicating that the trend in late 2023 of declining inflation had been interrupted. At the beginning of the year, many economists and analysts had expected that the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) would begin cutting its target for the federal funds rate sometime in the middle of the year. But with inflation persisting above the Fed’s 2 percent inflation target, it has become likely that the FOMC will wait until later in the year to start cutting its target and might decide to leave the target unchanged through the remainder of 2024.

Accordingly, economists and policymakers were intently awaiting the report from the Bureau of Labor Statistics (BLS) on the consumer price index (CPI) for April. The report released this morning showed a slight decrease in inflation, although the inflation rate remains well above the Fed’s 2 percent target. (Note that, as we discuss in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5), the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI in evaluating whether it is hitting its 2 percent inflation target.)

The inflation rate for April measured by the percentage change in the CPI from the same month in the previous month—headline inflation—was 3.4 percent—about the same as economists had expected—down from 3.5 percent in March. As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.6 percent in April, down from 3.8 percent in March.

If we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the declines in the inflation rate are larger. Headline inflation declined from 4.6 percent in March to 3.8 percent in April. Core inflation declined from 4.4 percent in March to 3.6 percent in April. Note that the value for core inflation is the same whether we measure over 12 months or over 1 month. Overall, we can say that inflation seems to have cooled in April, but it still remains well above the Fed’s 2 percent target.

As has been true in recent months, the path of inflation in the prices of services has been concerning. As we’ve noted in earlier posts, Federal Reserve Chair Jerome Powell has emphasized that as supply chain problems have gradually been resolved, inflation in the prices of goods has been rapidly declining. But inflaion in services hasn’t declined nearly as much. Powell has been particularly concernd about how slowly the price of housing has been declining, a point he made again in the press conference that followed the most recent FOMC meeting.

The following figure shows the 1-month inflation rate in service prices and in service prices not included including housing rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023, but inflation in service prices slowed markedly from 6.6 percent in March to 4.4 percent in April. Inflation in service prices not including housing rent declined more than 50 percent, from 8.9 percent in March to 3.4 percent in April. But, again, even though inflation in service prices declined in April, as the figure shows, the 1-month inflation in services is volatile and even these smaller increases aren’t yet consistent with the Fed meeting its 2 percent inflation target.

Finally, in order to get a better estimate of the underlying trend in inflation, some economists look at median inflation, which is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. As the following figure shows, at 4.3 percent, median inflation in April was unchanged from its value in March.

Today’s report was good news for the Fed in its attempts to reduce the inflation rate to its 2 percent target without pushing the U.S. economy into a recession. But Fed Chair Jerome Powell and other members of the FOMC have made clear that they are unlikely to begin cutting the target for the federal funds rate until they receive several months worth of data indicating that inflation has clearly resumed the downward path it was on during the last months of 2023. The unexpectedly high inflation data for the first three months of 2024 has clearly had a significant effect on Fed policy. Powell was quoted yesterday as noting that: “We did not expect this to be a smooth road, but these [inflation readings] were higher than I think anybody expected,”

How Has Inflation Affected People at Different Income Levels?

Photo courtesy of Lena Buonanno

In the new 9^th edition of Macroeconomics, in Chapter 9, Section 9.7 (Economics, Chapter 19, Section 19.7 and Essentials of Economics, Chapter 13, Section 13.7), we have an Apply the Concept feature that looks at research conducted by economists at the U.S. Bureau of Labor Statistics into the effects of inflation on households at different income levels. That research involved looking at the differences between the mix of goods that households at different income levels consume and at differences in increases in the wages they earn. The following figure, reproduced from this feature shows that as a percentage of their total consumption expenditures households with low incomes spend more on housing and food, and less on transportation and recreation than do households with high incomes.

During the three-year period from March 2020 to April 2023, wages increased faster than did prices for households with low incomes, while wages increased at a slower than did prices for households with high incomes. We concluded from this research that: “during this period, workers with lower incomes were hurt less by the effects of inflation than were workers with higher incomes.”

The Congressional Budget Office (CBO) has just released a new study that uses different data to arrive at a similar conclusion. The CBO divided households into five equal groups, or quintiles, from the 20 percent with the lowest incomes to the 20 percent with the highest incomes. The following table shows how income quintiles divide their consumption across different broad categories of goods and services. For example, compared with households in the highest income quintile, households in the lowest income quintile spend a much larger fraction of their budget on rent and a significantly larger fraction on food eaten at home. Households in the lowest quintile spent significantly less on “other services,” which include spending on hotels and on car maintenance and repair.

The CBO study measures the effect of inflation over the past four years on different income quintiles by comparing the change in the fraction of their incomes households needed to buy the same bundle of goods and services in 2024 that they bought in 2019. The first figure below shows the result when household income includes only market income—primarily wages and salaries. The second figure shows that result when transfer payments—such as Social Security benefits received by retired workers and unemployment benefits received by unemployed workers—are added to market income. (The values along the vertical axis are percentage points.)

The fact that, in both figures, the fraction of each quintiles’ income required to buy the same bundle of goods and services is negative means that between 2019 and 2023 income increased faster than prices for all income quintiles. Looking at the bottom figure, households in the highest income quintile could spend 6.3 percentage points less of their income in 2024 to buy the same bundle of goods and services they had bought in 2019. Households in the lowest income quintile could spend 2.0 percentage points less. Households in the middle income quintile had the smallest reduction—0.3 percentage point—of their income to buy the same bundle of goods and services.

It’s worth keeping mind that the CBO data represent averages within each quintile. There were certainly many households, particularly in the lower income quintiles, that needed to spend a larger precentage of their income in 2024 to buy the same bundle of goods and services that they had bought in 2019, even though, as a group, the quintile they were in needed a smaller percentage.

Is Sugar All You Need?

Dylan’s Candy Bar in New York City (Photo from the New York Times)

Can prices of one type of good track inflation accurately? As we’ve discussed in a number of blog posts (for instance, here, here, and here), there is a debate among economists about which of the data series on the price level does the best job of tracking the underlying rate of inflation.

The most familiar data series on the price level is the consumer price index (CPI). Core CPI excludes the—typically volatile—food and energy prices. In gauging whether it is achieving its goal of 2 percent annual inflation, the Federal Reserve uses the personal consumption expenditures (PCE) price index. The PCE price index includes the prices of all the goods and services included in the consumption category of GDP, which makes it a broader measure of inflation than the CPI. To understand the underlying rate of inflation, the Fed often focuses on movements in core PCE.

With the increase in inflation that started in the spring of 2021, some economists noted that the prices of particular goods and services—such as new and used cars and housing—were increasing much more rapidly than other prices. So some economists concentrated on calculating inflation rates that excluded these or other prices from either the CPI or the PCE.

For example, the following figure shows the inflation rate measured by the percentage change from the same month in the previous year using the median CPI and using the trimmed mean PCE. If we list the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. The trimmed mean measure of PCE inflation is compiled by economists at the Federal Reserve Bank of Dallas by dropping from the PCE the goods and services that have the highest and lowest rates of inflation. During the period when the inflation rate was increasing rapidly during 2021 and 2022, CPI inflation increased more and was more volatile than PCE inflation. That difference between movements in the two price level series is heightened when comparing median inflation in the CPI with trimmed mean inflation in the PCE. In particular, using trimmed mean PCE, the inflation of late 2021 and 2022 seems significantly milder than it does using median CPI.

The United States last experienced high inflation rates in the 1970s, when few people used personal computers and easily downloading macroeconomic data from the internet wasn’t yet possible. Today, it’s comparatively easy to download data on the CPI and PCE and manipulate them to investigate how the inflation rate would be affected by dropping the prices of various goods and services. It’s not clear, though, that this approach is always helpful in determining the underlying inflation rate. In a market system, the prices of many goods and services will be affected in a given month by shifts in demand and supply that aren’t related to general macroeconomic conditions.

In a recent blog post, economists B. Ravikumar and Amy Smaldone of the Federal Reserve Bank of St. Louis note that there is a strong correlation between movements in the prices of the “Sugar and Sweets” component of the CPI and movements in the overall CPI. Their post includes the following two figures. The first shows the price level since 1947 calculated using the prices of all the goods and services in the CPI (blue line) and the price level calculated just using the prices of goods included in the “Sugar and Sweets” category (red line). The data are adjusted to an index where the value for each series in January 1990 equals 100. The second figure shows the percentage change from the previous month for both series for the months since January 2000.

The two figures show an interesting—and perhaps surprising—correlation between sugar and sweets prices and all prices included in the CPI. The St. Louis Fed economists note that although the CPI is only published once per month, prices on sugar and sweets are available weekly. Does that mean that we could use prices on sugar and sweets to predict the CPI? That seems unlikely. First, consider that the sugar and sweets category of the CPI consists of three sub-categories:

White, brown, and raw sugar and natural and artificial sweetners
Chocolate and other types of candy, fruit flavored rolls, chewing gum and breath mints
Other sweets, including jelly and jams, honey, pancake syrup, marshmallows, and chocolate syrup

Taken together these products are less than 3 percent of the products included in the CPI. In addition, the prices of the goods in this category can be heavily dependent on movements in sugar and cocoa prices, which are determined in world wide markets. For instance, the following figure shows the world price of raw cocoa, which soared in 2024 due to bad weather in West Africa, where most cocoa is grown. There’s no particular reason to think that factors affecting the markets for sugar and cocoa will also affect the markets in the United States for automobiles, gasoline, furniture, or most other products.

In fact, as the first figure below shows, if we look at the inflation rate calculated as the percentage change from the same month in the previous year, movements in sugar and sweets prices don’t track very closely movements in the overall CPI. Beginning in the summer of 2022—an important period when the inflation that began in the spring of 2021 peaked—inflation in sugar and sweets was much higher than overall CPI inflation. Anyone using prices of sugar and sweets to forecast what was happening to overal CPI inflation would have made very poor predictions. We get the same conclusion from comparing inflation calculated by compounding the current month’s rate over an entire year: Inflation in sugar and sweets prices is much more volatile than is overall CPI inflation. That conclusion is unsurprising given that food prices are generally more volatile than are the prices of most other goods.

It can be interesting to experiment with excluding various prices from the CPI or the PCE or with focusing on subcategories of these series. But it’s not clear at this point whether any of these adjustments to the CPI and the PCE, apart from excluding all food and energy prices, gives an improved estimate of the underlying rate of inflation.

What Can We Conclude from a Weaker than Expected Employment Report?

This morning (May 3), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report for April. The report has two estimates of the change in employment during the month: one estimate from the establishment survey, often referred to as the payroll survey, and one from the household survey. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), many economists and policymakers at the Federal Reserve believe that employment data from the establishment survey provides a more accurate indicator of the state of the labor market than do either the employment data or the unemployment data from the household survey. (The groups included in the employment estimates from the two surveys are somewhat different, as we discuss in this post.)

According to the establishment survey, there was a net increase of 175,000 jobs during April. This increase was well below the increase of 240,000 that economists had forecast in a survey by the Wall Street Journal and well below the net increase of 315,000 during March. The following figure, taken from the BLS report, shows the monthly net changes in employment for each month during the past to years.

As the following figure shows, the net change in jobs from the household survey moves much more erratically than does the net change in jobs in the establishment survey. The net increase in jobs as measured by the household survey fell from 498,000 in March to 25,000 in April.

The unemployment rate, which is also reported in the household survey, ticked up slightly from 3.8 percent to 3.9 percent. It has been below 4 percent every month since February 2022.

The establishment survey also includes data on average hourly earnings (AHE). As we note in this recent post, many economists and policymakers believe the employment cost index (ECI) is a better measure of wage pressures in the economy than is the AHE. The AHE does have the important advantage that it is available monthly, whereas the ECI is only available quarterly. The following figure show the percentage change in the AHE from the same month in the previous year. The 3.9 percent value for April continues a downward trend that began in February.

The following figure shows wage inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month wage inflation, whereas this figure shows 1-month wage inflation.) One-month wage inflation is much more volatile than 12-month inflation—note the very large swings in 1-month wage inflation in April and May 2020 during the business closures caused by the Covid pandemic.

The 1-month rate of wage inflation of 2.4 percent in April is a significant decrease from the 4.2 percent rate in March, although it’s unclear whether the decline was a sign that the labor market is weakening or reflected the greater volatility in wage inflation when calculated this way.

The macrodata released during the first three months of the year had, by and large, indicated strong economic growth, with the pace of employment increases being particularly rapid. Wages were also increasing at a pace above that during the pre-Covid period. Inflation appeared to be stuck in the range of 3 percent to 3.5 percent, above the Fed’s target inflation rate of 2 percent.

Today’s “Employment Situation” report may be a first indication that growth is slowing sufficiently to allow the inflation rate to fall back to 2 percent. This is the outcome that Fed Chair Jerome Powell indicated in his press conference on Wednesday that he expected to occur at some point during 2024. Financial markets reacted favorably to the release of the report with stock prices jumping and the interest rate on the 10-year Treasury note falling. Many economists and Wall Street analysts had concluded that the Fed’s policy-making Federal Open Market Committee (FOMC) was likely to keep its target for the federal funds rate unchanged until late in the year and might not institute a cut in the target at all this year. Today’s report caused some Wall Street analysts to conclude, as the headline of an article in the Wall Street Journal put it, “Jobs Data Boost Hopes of a Late-Summer Rate Cut.”

This reaction may be premature. Data on employment from the establishment survey can be subject to very large revisions, which reinforces the general caution against putting too great a weight one month’s data. Its most likely that the FOMC would need to see several months of data indicating a slowing in economic growth and in the inflation rate before reconsidering whether to cut the target for the federal funds rate earlier than had been expected.

The FOMC Follows the Expected Course in Its Latest Meeting

Chair Jerome Powell at a meeting of the Federal Open Market Committee (photo from federalreserve.gov)

At the beginning of the year, there was an expectation among some economists and policymakers that the Fed’s policy-making Federal Open Market Committee (FOMC) would begin cutting its target range for the federal funds rate at the meeting that ended today (May 1). The Fed appeared to be bringing the U.S. economy in for a soft landing—inflation returning to the Fed’s 2 percent target without a recession occurring.

During the first quarter of 2024, production and employment have been expanding more rapidly than had been expected and inflation has been higher than expected. As a result, the nearly universal expectation prior to this meeting was that the FOMC would leave its target for the federal funds rate unchanged. Some economists and investment analysts have begun discussing the possiblity that the committee might not cut its target at all during 2024. The view that interest rates will be higher for longer than had been expected at the beginning of the year has contributed to increases in long-term interest rates, including the interest rates on the 10-year Treasury Note and on residential mortgage loans.

The statement that the FOMC issued after the meeting confirmed the consensus view:

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Job gains have remained strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated. In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.”

In his press conference after the meeting, Fed Chair Jerome Powell emphasized that the FOMC was unlikely to cut its target for the federal funds rate until data indicated that the inflation rate had resumed falling towards the Fed’s 2 percent target. At one point in the press conference Powell noted that although it was taking longer than expected for the inflation rate to decline he still expected that the pace of economic actitivity was likely to slow sufficiently to allow the decline to take place. He indicated that—contrary to what some economists and investment analysts had suggested—it was unlikely that the FOMC would raise its target for the federal funds rate at a future meeting. He noted that the possibility of raising the target was not discussed at this meeting.

Was there any news in the FOMC statement or in Powell’s remarks at the press conference? One way to judge whether the outcome of an FOMC meeting is consistent with the expectations of investors in financial markets prior to the meeting is to look at movements in stock prices during the time between the release of the FOMC statement at 2 pm and the conclusion of Powell’s press conference at about 3:15 pm. The following figure from the Wall Street Journal, shows movements in the three most widely followed stock indexes—the Dow Jones Industrial Average, the S&P 500, and the Nasdaq composite. (We discuss movements in stock market indexes in Macroeconomics and Essentials of Economics, Chapter 6, Section 6.2 and in Economics, Chapter 8, Section 8.2.)

If either the FOMC statement or the Powell’s remarks during his press conference had raised the possibility that the committee was considering raising its target for the federal funds rate, stock prices would likely have declined. The decline would reflect investors’ concern that higher interest rates would slow the economy, reducing future corporate profits. If, on the other hand, the statement and Powell’s remarks indicated that the committee would likely cut its target for the federal funds rate relatively soon, stock prices would likely have risen. The figure shows that stock prices began to rise after the 2 pm release of the FOMC statement. Prices rose further as Powell seemed to rule out an increase in the target at a future meeting and expressed confidence that inflation would resume declining toward the 2 percent target. But, as often happens in the market, this sentiment reversed towards the end of Powell’s press conference and two of the three stock indexes ended up lower at the close of trading at 4 pm. Presumably, investors decided that on reflection there was no news in the statement or press conference that would change the consensus on when the FOMC might begin lowering its target for the federal funds rate.

The next signficant release of macroeconomic data will come on Friday when the Bureau of Labor Statistics issues its employment report for April.

Latest Wage Data Another Indication of the Persistence of Inflation

Photo courtesy of Lena Buonanno.

The latest significant piece of macroeconomic data that will be available to the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) before it concludes its meeting tomorrow is the report on the Employment Cost Index (ECI), released this morning by the Bureau of Labor Statistics (BLS). As we’ve noted in earlier posts, as a measure of the rate of increase in labor costs, the FOMC prefers the ECI to average hourly earnings (AHE) .

The AHE is calculated by adding all of the wages and salaries workers are paid—including overtime and bonus pay—and dividing by the total number of hours worked. As a measure of how wages are increasing or decreasing during a particular period, AHE can suffer from composition effects because AHE data aren’t adjusted for changes in the mix of occupations workers are employed in. For example, during a period in which there is a decline in the number of people working in occupations with higher-than-average wages, perhaps because of a downturn in some technology industries, AHE may show wages falling even though the wages of workers who are still employed have risen. In contrast, the ECI holds constant the mix of occupations in which people are employed. The ECI does have the drawback, that it is only available quarterly whereas the AHE is available monthly.

The data released this morning indicate that labor costs continue to increase at a rate that is higher than the rate that is likely needed for the Fed to hit its 2 percent price inflation target. The following figure shows the percentage change in the employment cost index for all civilian workers from the same quarter in 2023. The blue line looks only at wages and salaries while the red line is for total compensation, including non-wage benefits like employer contributions to health insurance. The rate of increase in the wage and salary measure decreased slightly from 4.4 percent in the fourth quarter of 2023 to 4.3 percent in the first quarter of 2024. The rate of increase in compensation was unchanged at 4.2 percent in both quarters.

If we look at the compound annual growth rate of the ECI—the annual rate of increase assuming that the rate of growth in the quarter continued for an entire year—we find that the rate of increase in wages and salaries increased from 4.3 percent in the fourth quarter of 2023 to 4.5 percent in the first quarter of 2024. Similarly, the rate of increase in compensation increased from 3.8 percent in the third quarter of 2023 to 4.5 percent in the first quarter of 2024.

Some economists and policymakers prefer to look at the rate of increase in ECI for private industry workers rather than for all civilian workers because the wages of government workers are less likely to respond to inflationary pressure in the labor market. The first of the following figures shows the rate of increase of wages and salaries and in total compensation for private industry workers measured as the percentage increase from the same quarter in the previous year. The second figure shows the rate of increase calculated as a compound growth rate.

The first figure shows a slight decrease in the rate of growth of labor costs from the fourth quarter of 2023 to the first quarter of 2024, while the second figure shows a fairly sharp increase in the rate of growth.

Taken together, these four figures indicate that there is little sign that the rate of increase in employment costs is falling to a level consistent with a 2 percent inflation rate. At his press conference tomorrow afternoon, following the conclusion of the FOMC’s meeting, Fed Chair Jerome Powell will give his thoughts on the implications for future monetary policy 0f recent macroeconomic data.

Latest Monthly Report on PCE Inflation Confirms Inflation Remains Stubbornly High

Federal Reserve Chair Jerome Powell (Photo from federalreserve.gov)

In a post yesterday, we noted that the quarterly data on the personal consumption expenditures (PCE) price index in the latest GDP report released by the Bureau of Economic Analysis (BEA) indicated that inflation was running higher than expected. Today (April 26), the BEA released its “Personal Income and Outlays” report for March, which includes monthly data on the PCE. The monthly data are consistent with the quarterly data in showing that PCE inflation remains higher than the Federal Reserve’s 2 percent annual inflation target. (A reminder that PCE inflation is particularly important because it’s the inflation measure the Fed uses to gauge whether it’s hitting its inflation target.)

The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—with inflation measured as the percentage change in the PCE from the same month in the previous year. Many economists believe that core inflation gives a better gauge of the underlying inflation rate. Measured this way, PCE inflation increased from 2.5 percent in February to 2.7 percent in March. Core PCE inflation remained unchanged at 2.8 percent.

The following figure shows PCE inflation and core PCE inflation calculated by compounding the current month’s rate over an entire year. (The figure above shows what is sometimes called 12-month inflation, while this figure shows 1-month inflation.) Measured this way, PCE inflation declined from 4.1 percent in February to 3.9 percent in March. Core PCE inflation increased from 3.2 percent in February to 3.9 in March. So, March was another month in which both PCE inflation and core PCE inflation remained well above the Fed’s 2 percent inflation target.

The following figure shows other ways of gauging inflation by including the 12-month inflation rate in the PCE (the same as shown in the figure above—although note that PCE inflation is now the red line rather than the blue line), inflation as measured using only the prices of the services included in the PCE (the green line), and the rate of inflation (the blue line) excluding the prices of housing, food, and energy. Fed Chair Jerome Powell has said that he is particularly concerned by elevated rates of inflation in services. Some economists believe that the price of housing isn’t accurately measured in the PCE, which makes it interesting to see if excluding the price of housing makes much difference in calculating the inflation rate. All three measures of inflation increased from February to March, with inflation in services remaining well above overall inflation and inflation excluding the prices of housing, food, and energy being somewhat lower than overall inflation.

The following figure uses the same three inflation measures as the figure above, but shows the 1-month inflation rate rather than the 12-month inflation rate. Measured this way, inflation in services increased sharply from 3.2 percent in February to 5.0 percent in March. Inflation excluding the prices of housing, food, and energy doubled from 2.0 percent in February to 4.1 percent in March.

Overall, the data in this report indicate that the decline in inflation during the second half of 2023 hasn’t continued in the first three months of 2024. In fact, the inflation rate may be slightly increasing. As a result, it no longer seems clear that the Fed’s policy-making Federal Open Market Committee (FOMC) will cut its target for the federal funds rate this year. (We discuss the possibility that the FOMC will keep its target unchanged through the end of the year in this blog post.) At the press conference following the FOMC’s next meeting on April 30-May 1, Fed Chair Jerome Powell may explain what effect the most recent data have had on the FOMC’s planned actions during the remainder of the year.

Does the Latest GDP Report Indicate the U.S. Economy Is Entering a Period of Stagflation?

Arthur Burns was Fed chair during the stagflation of the 1970s. (Photo from the Wall Street Journal)

This morning, Thursday April 25, the Bureau of Economic Analysis (BEA) released its advance estimate of real GDP growth during the first quarter of 2024. The two most striking points in the report are, first, that real GDP increased in the first quarter at an annual rate of only 1.6 percent—well below the 2.5 percent increase expected in a survey of economists and the 2.7 percent increase indicated by the Federal Reserve Bank of Atlanta’s GDPNow forecast. As the following figure shows, the growth rate of real GDP has declined in each of the last two quarters from the very strong growth rate of 4.9 percent during the third quarter of 2023.

The second striking point in the report was an unexpected increase in inflation, as measured using the personal consumption expenditures (PCE) price index. As the following figure shows, PCE inflation (the red line), measured as a compound annual rate of change, increased from 1.8 percent in the fourth quarter of 2023 to 3.4 percent in the first quarter of 2024. Core PCE inflation (the blue line), which excludes food and energy prices, increased from 2.0 percent in the fourth quarter of 2023 to 3.7 percent in the first quarter of 2024. These data indicate that inflation in the first quarter of 2024 was running well above the Federal Reserve’s 2.0 percent target.

A combination of weak economic growth and above-target inflation poses a policy dilemma for the Fed. As we discuss in Macroeconomics, Chapter 13, Section 13.3 (Economics, Chapter 23, Section 23.3), the combination of slow growth and inflation is called stagflation. During the 1970s, when the U.S. economy suffered from stagflation, Fed Chair Arthur Burns (whose photo appears at the beginning of this post) was heavily criticized by members of Congress for his inability to deal with the problem. Stagflation poses a dilemma for the Fed because using an expansionary monetary policy to deal with slow economic growth may cause the inflation rate to rise. Using a contractionary monetary policy to deal with high inflation can cause growth to slow further, possibly pushing the economy into a recession.

Is Fed Chair Jerome Powell in as difficult a situation as Arthur Burns was in the 1970s? Not yet, at least. First, Burns faced a period of recession—declining real GDP and rising unemployment—whereas currently, although economic growth seems to be slowing, real GDP is still rising and the unemployment rate is still below 4 percent. In addition, the inflation rate in these data are below 4 percent, far less than the 10 percent inflation rates during the 1970s.

Second, it’s always hazardous to draw conclusions on the basis of a single quarter’s data. The BEA’s real GDP estimates are revised several times, so that the value for the first quarter of 2024 may well be revised significantly higher (or lower) in coming months.

Third, the slow rate of growth of real GDP in the first quarter is accounted for largely by a surge in imports—which are subtracted from GDP—and a sharp decline in inventory investment. Key components of aggregate demand remained strong: Consumption expenditures increased at annual rate of 2.5 per cent and business investment increased at an annual rate of 3.2 percent. Residential investment was particularly strong, growing at an annual rate 0f 13.2 percent—despite the effects of rising mortgage interest rates. One way to strip out the effects of net exports, inventory investment, and government purchases—which can also be volatile—is to look at final sales to domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers declined only modertately from 3.3 percent in the fourth quarter of 2023 to 3.1 percent in the first quarter of 2024.

Looking at these details of the GDP report indicate that growth may have slowed less during the first quarter than the growth rate of real GDP seems to indicate. Investors on Wall Street may have come to this same conclusion. As shown by this figure from the Wall Street Journal, shows that stock prices fell sharply when trading opened at 9:30 am, but by 2 pm has recovered some of their losses as investors considered further the implications of the GDP report. (As we discuss in Macroeconomics, Chapter 6, Section 6.2 and Economics, Chapter 8, Section 8.2, movements in stock price indexes can provide some insight into investors’ expectations of future movements in corporate profits, which, in turn, depend in part on future movements in economic growth.)

Finally, we may get more insight into the rate of inflation tomorrow morning when the BEA releases its report on “Personal Income and Outlays,” which will include data on PCE inflation during March. The monthly PCE data provide more current information than do the quarterly data in the GDP report.

In short, today’s report wasn’t good news, but may not have been as bad as it appeared at first glance. We are far from being able to conclude that the U.S. economy is entering into a period of stagflation.

How Will the Fed React to Another High Inflation Report?

In a recent podcast we discussed what actions the Fed may take if inflation continues to run well above the Fed’s 2 percent target. We are likely a step closer to finding out with the release this morning (April 10) by the Bureau of Labor Statistics (BLS) of data on the consumer price index (CPI) for March. The inflation rate measured by the percentage change in the CPI from the same month in the previous month—headline inflation—was 3.5 percent, slightly higher than expected (as indicated here and here). As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.8 percent, the same as in January.

If we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year—the values seem to confirm that inflation, while still far below its peak in mid-2022, has been running somewhat higher than it did during the last months of 2023. Headline CPI inflation in March was 4.6 percent (down from 5.4 percent in February) and core CPI inflation was 4.4 percent (unchanged from February). It’s worth bearing in mind that the Fed’s inflation target is measured using the personal consumption expenditures (PCE) price index, not the CPI. But CPI inflation at these levels is not consistent with PCE inflation of only 2 percent.

“Part of the reason for the modest decline of nonhousing services inflation so far is that many of these services were less affected by global supply chain bottlenecks and are generally thought to be less interest sensitive than other sectors such as housing or durable goods. Production of these services is also relatively labor intensive, and the labor market remains tight. Given the size of this sector, some further progress here will be essential to restoring price stability.”

The following figure shows the 1-month inflation rate in services prices and in services prices not included including housing rent. Some economists believe that the rent component of the CPI isn’t well measured and can be volatile, so it’s worthwhile to look at inflation in service prices not including rent. The figure shows that inflation in all service prices has been above 4 percent in every month since July 2023. Inflation in service prices increased from 5.8 percent in February to 6.6 percent in March . Inflation in service prices not including housing rent was even higher, increasing from 7.5 percent in February to 8.9 percent in March. Such large increases in the prices of services, if they were to continue, wouldn’t be consistent with the Fed meeting its 2 percent inflation target.

Finally, some economists and policymakers look at median inflation to gain insight into the underlying trend in the inflation rate. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates. As the following figure shows, although median inflation declined in March, it was still high at 4.3 percent. Median inflation is volatile, but the trend has been generally upward since July 2023.

Financial investors, who had been expecting that this CPI report would show inflation slowing, reacted strongly to the news that, in fact, inflation had ticked up. As of late morning, the Dow Jones Industrial Average had decline by nearly 500 points and the S&P 5o0 had declined by 59 points. (We discuss the stock market indexes in Macroeconomics, Chapter 6, Section 6.2 and in Microeconomics and Economics, Chapter 8, Section 8.2.) The following figure from the Wall Street Journal shows the sharp reaction in the bond market as the interest rate on the 10-year Treasury note rose sharply following the release of the CPI report.

Lower stock prices and higher long-term interest rates reflect the fact that investors have changed their views concerning when the Fed’s Federal Open Market Committee (FOMC) will cut its target for the federal funds and how many rate cuts there may be this year. At the start of 2024, the consensus among investors was for six or seven rate cuts, starting as early as the FOMC’s meeting on March 19-20. But with inflation remaining persistently high, investors had recently been expecting only two or three rate cuts, with the first cut occurring at the FOMC’s meeting on June 11-12. Two days ago, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis raised the possibility that the FOMC might not cut its target for the federal funds rate during 2024. Some economists have even begun to speculate that the FOMC might feel obliged to increase its target in the coming months.

After the FOMC’s next meeting on April 30-May 1 first, Chair Powell may provide some additional information on the committee’s current thinking.

Another Surprisingly Strong Employment Report

Photo from Reuters via the Wall Street Journal.

On Friday, April 5—the first Friday of the month—the Bureau of labor Statistics (BLS) released its “Employment Situation” report with data on the state of the labor market in March. The BLS reported a net increase in employment during March of 303,000, which was well above the increase that economists had been expecting. The previous estimates of employment in January and February were revised upward by 22,000 jobs. (We also discuss the employment report in this podcast.)

Employment increases during the second half of 2023 had slowed compared with the first half of the year. But, as the following figure from the BLS report shows, since December 2023, employment has increased by more than 250,000 in each month. These increases are far above the estimated increases of 70,000 to 100,000 new jobs needed to keep up with population growth. (But note our later discussion of this point.)

The unemployment rate had been expected to stay steady at 3.9 percent, but declined slightly to 3.8 percent. As the following figure shows, the unemployment rate has been remarkably stable for more than two years and has been below 4.0 percent each month since December 2021. The members of the Federal Open Market Committee (FOMC) expect that the unemployment rate for 2024 will be 4.0 percent, a forcast that is beginning to seem too high.

The monthly employment number most commonly reported in media accounts is from the establishment survey (sometimes referred to as the payroll survey), whereas the unemployment rate is taken from the household survey. The results of both surveys are included in the BLS’s monthly “Employment Situation” report. As we discuss in Macroeconomics, Chapter 9, Section 9.1 (Economics, Chapter 19, Section 19.1), many economists and policymakers at the Federal Reserve believe that employment data from the establishment survey provides a more accurate indicator of the state of the labor market than do either the employment data or the unemployment data from the household survey.

As we noted in a previous post, whereas employment as measured by the establishment survey has been increasing each month, employment as measured by the household surve declined each month from December 2023 through February 2024. But, as the following figure shows, this trend was reversed in March, with employment as measured by the household survey increasing 498,000—far more than the 303,000 increase in employment in establishment survey. This reversal may be another indication of the underlying strength of the labor market.

As the following figure shows, despite the substantial increases in employment, wages, as measured by the percentage change in average hourly earnings from the same month in the previous year, have been trending down. The increase in average hourly earnings declined from 4.3 percent February in to 4.1 percent in March.

Wages increased by 6.1 percent in January 2024, 2.1 percent in February, and 4.2 percent in March. So, the 1-month rate of wage inflation did show an increase in March, although it’s unclear whether the increase was a result of the strength of the labor market or reflected the greater volatility in wage inflation when calculated this way.

Some economists and policymakers are surprised that low levels of unemployment and large monthly increases in employment have not resulted in greater upward pressure on wages. One possibility is that the supply of labor has been increasing more rapidly than is indicated by census data. In a January report, the Congressional Budget Office (CBO) argued that the Census Bureau’s estimate of the population of the United States is too low by about 6 million people. This undercount is attributable, according to the CBO, largely the Census Bureau having underestimated the amount of immigration that has occurred. If the CBO is correct, then the economy may need to generate about 200,000 net new jobs each month to accomodate the growth of the labor force, rather than thw 80,000 to 100,000 we mentioned earlier in this post.

Federal Reserve Chair Jerome Powell noted in a press conference following the most recent meeing of the FOMC that: “Strong job creation has been accompanied by an increase in the supply of workers, reflecting increases in participation among individuals aged 25 to 54 years and a continued strong pace of immigration.” As a result:

“what you would have is potentially kind of what you had last year, which is a bigger economy where inflationary pressures are not increasing. In fact, they were decreasing. So you can have that if you have a continued supply-side activity that we had last year with—both with supply chains and also with, with growth in the size of the labor force.”

If Powell is correct, in the coming months the U.S. economy may be able to sustain rapid increases in employment without those increases leading to an increase in the rate of inflation.