Ch19: Unemployment and Inflation – Page 8 – HubbardOBrienEconomics.com Blog

Strong Jobs Report in the Context of Annual Revisions to the Establishment and Household Surveys

Photo courtesy of Lena Buonanno

This morning (February 7), the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for January. This report was particularly interesting because it includes data reflecting the annual benchmark revision to the establishment, or payroll, survey and the annual revision of the household survey data to match new population estimates from the Census Bureau.

According to the establishment survey, there was a net increase of 143,000 jobs during January. This increase was below the increase of 169,000 to 175,000 that economists had forecast in surveys by the Wall Street Journal and bloomberg.com. The somewhat weak increase in jobs during January was offset by upward revisions to the initial estimates for November and December. The previously reported increases in employment for those months were revised upward by a total of 100,000 jobs. (The BLS notes that: “Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.”)

The BLS also announced the results of its annual revision of the payroll employment data benchmarked to March 2024. The revisions are mainly based on data from the Quarterly Census of Employment and Wages (QCEW). The data in payroll survey are derived from a sample of 300,000 establishments, whereas the QCEW is based on a much more comprehensive count of workers covered by state unemployment insurance programs. The revisions indicated that growth in payroll employment between March 2023 and March 2024 had been overstated by 598,000 jobs. Although large in absolute scale, the revisions equal only 0.4 percent of total employment. In addition, as we discussed in this blog post last August, initially the BLS had estimated that the overstatement in employment gains during this period was an even larger 818,000 jobs. (The BLS provides a comprehensive discuss of its revisions to the establishment employment data here.)

The following table shows the revised estimates for each month of 2024, based on the new benchmarking.

The BLS also revised the household survey data to reflect the latest population estimates from the census bureau. Unlike with the establishment data, the BLS doesn’t adjust the historical household data in light of the population benchmarking. However, the BLS did include two tables in this month’s jobs report illustrating the effect of the new population benchmark. The following table from the report shows the effect of the benchmarking on some labor market data for December 2024. The revision increases the estimate of the civilian noninstitutional population by nearly 3 million, most of which is attributable to an increase in the estimated immigrant population. The increase in the estimate of the number of employed workers was also large at 2 million. (The BLS provides a discussion of the effects of its population benchmarking here.)

The following table shows how the population benchmarking affects changes in estimates of labor market variables between December 2024 and January 2025. The population benchmarking increases the net number of jobs created in January by 234,000 and reduces the increase in the number of persons unemployed by 142,000.

As the following figure shows, the unemployment rate, as reported in the household survey, decreased from 4.1 percent in December to 4.0 percent in January. The figure shows that the unemployment rate has fluctuated in a fairly narrow range over the past year.

The establishment survey also includes data on average hourly earnings (AHE). As we’ve noted in previous posts, 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 of being available monthly, whereas the ECI is only available quarterly. The following figure shows the percentage change in the AHE from the same month in the previous year. AHE increased 4.1 percent in January, which was unchanged from the December increase. By this measure, wage growth is still somewhat higher than is consistent with annual price inflation running at the Fed’s target of 2 percent.

There isn’t much in today’s jobs report to change the consensus view that the Fed’s policymaking Federal Open Market Committee (FOMC) will leave its target for the federal funds rate unchanged at its next meeting on March 18-19. One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 91.5 percent to the FOMC keeping its target range for the federal funds rate unchanged at the current range of 4.25 percent to 4.50 percent at the March meeting. Investors assign a probability of only 8.5 percent to the FOMC cutting its target range by 25 basis points at that meeting.

JOLTS Report Indicates the Labor Market Remains Strong

Image generated by ChatGTP-4o

Earlier this week, the Bureau of Labor Statistics (BLS) released its “Job Openings and Labor Turnover” (JOLTS) report for December 2024. The report indicated that labor market conditions remain strong, with most indicators being in line with their values from 2019, immediately before the pandemic. The following figure shows that, at 4.5 percent, the rate of job openings remains in the same range as during the previous six months. While well down from the peak job opening rate of 7.4 percent in March 2022, the rate of job openings was the same as during the summer of 2019 and above the rates during most of the period following the Great Recession of 2007–2009.

(The BLS defines a job opening as a full-time or part-time job that a firm is advertising and that will start within 30 days. The rate of job openings is the number of job openings divided by the number of job openings plus the number employed workers, multiplied by 100.)

In the following figure, we compare the total number of job openings to the total number of people unemployed. The figure shows a slow decline from a peak of more than 2 job openings per unemployed person in the spring of 2022 to 1.1 job openings per unemployed person in December 2024—about the same as in 2019 and early 2020, before the pandemic. Note that the number is still above 1.0, indicating that the demand for labor is still high, although no higher than during the strong labor market of 2019.

The rate at which workers are willing to quit their jobs is an indication of how they perceive the ease of finding a new job. As the following figure shows, the quit rate declined slowly from a peak of 3 percent in late 2021 and early 2022 to 2.0 percent in July 2024, the same value as in December 2024. That rate is below the rate during 2019 and early 2020. By this measure, workers’ perceptions of the state of the labor market may have deteriorated slightly in recent months.

The JOLTS data indicate that the labor market is about as strong as it was in the months prior to the start of the pandemic, but it’s not as historically tight as it was through most of 2022 and 2023. In recent months, workers may have become less optimistic about finding a new job if they quit their current job. The “Great Quitting,” which was widely discussed in the business press during the period of high quit rates in 2022 and 2023 would seem to be over.

On Friday morning, the BLS will release its “Employment Situation” report for January, which will provide additional data on the state of the labor market. (Note that the data in the JOLTS report lag the data in the “Employment Situation” report by one month.)

New Data on Inflation and Wage Growth Indicate that Inflation Is Still Running above Target

Photo courtesy of Lena Buonanno

Today (January 31), the BEA released monthly data on the PCE as part of its Personal Income and Outlays report. In addition, the Bureau of Labor Statistics (BLS) released quarterly data on the Employment Cost Index (ECI).

The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. The following figure shows PCE inflation (blue line) and core PCE inflation (red line)—which excludes energy and food prices—for the period since January 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in December PCE inflation (the blue line) was 2.8 percent, unchanged from November. Core PCE inflation (the red line) in December was also 2.8 percent, unchanged from November.

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 rose in December to 3.1 percent from 1.5 percent in November. Core PCE inflation rose in December to 1.9 percent from to 1.3 percent in November. Core inflation is generally a better measure of the underlying trend in inflation. So, 1-month core PCE inflation running below the Fed’s 2 percent target is an encouraging sign. But the usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure), so data from one month shouldn’t be overly relied on.

Turning to wages, as we’ve noted in earlier posts, the Fed’s policymaking Federal Open Market Committee (FOMC) prefers the employment cost index (ECI) to average hourly earnings (AHE) as a measure of the increase in labor costs.

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 this drawback: 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 ECI from the same quarter in the previous year. The blue line shows only wages and salaries of private industry workers, while the red line shows total compensation, including non-wage benefits like employer contributions to health insurance, for all civilian workers. The two measures of wage inflation follow similar paths. The rate of increase in the wage and salary measure decreased slightly from 3.9 percent in the third quarter of 2024 to 3.8 percent in the fourth quarter. The movement in the rate of increase in compensation was very similar, also decreasing from 3.9 percent in the third quarter of 2024 to 3.8 percent in the fourth quarter.

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 3.1 percent in the third quarter of 2024 to 3.6 percent in the fourth quarter. Similarly, the rate of increase in compensation increased from 3.2 percent in the fourth quarter of 2024 to 3.6 percent in the fourth quarter. So, this measure indicates that there has been some increase in the rate of wage inflation in the fourth quarter, although, again, we have to use caution in interpreting data from only one quarter.

Taken together, the PCE and ECI data released today indicate that the Fed still has a way to go before bringing about a soft landing—returning inflation to its 2 percent target without pushing the economy into a recession.

As Expected, the FOMC Leaves Its Target for the Federal Funds Rate Unchanged

Federal Reserve Chair Jerome Powell at a press conference following a meeting of the FOMC (photo from federalreserve.gov)

Members of the Fed’s Federal Open Market Committee (FOMC) had signaled that the committee was likely to leave its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent at its meeting today (January 29), which, in fact, was what they did. As Fed Chair Jerome Powell put it at a press conference following the meeting:

“We see the risks to achieving our employment and inflation goals as being roughly in balance. And we are attentive to the risks on both sides of our mandate. … [W]e do not need to be in a hurry to adjust our policy stance.”

The next scheduled meeting of the FOMC is March 18-19. It seems likely that the committee will also keep its target rate constant at that meeting. Although at his press conference, Powell noted that “We’re not on any preset course.” And that “Policy is well-positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.” The statement the committee released after the meeting showed that the decision to leave the target rate unchanged was unanimous.

The following figure shows, for the period since January 2010, the upper bound (the blue line) and lower bound (the red line) for the FOMC’s target range for the federal funds rate and the actual values of the federal funds rate (the green line) during that time. Note that the Fed is successful in keeping the value of the federal funds rate in its target range.

A week ago, President Donald Trump in a statement to the World Economic Forum in Davos, Switzerland noted his intention to take actions to reduce oil prices. And that “with oil prices going down, I’ll demand that interest rates drop immediately.” As we noted in this recent post about Fed Governor Michael Barr stepping down as Fed Vice Chair for Supervision, there are indications that the Trump administration may attempt to influence Fed monetary policy.

In his press conference, Powell was asked about the president’s statement and responded that he had “No comment whatever on what the president said.” When asked whether the president had spoken to him about the need to lower interest rates, Powell said that he “had no contact” with the president. Powell stated in response to another question that “I’m not going to—I’m not going to react or discuss anything that any elected politician might say ….”

As we noted earlier, it seems likely that the FOMC will leave its target for the federal funds rate unchanged at its meeting on March 18-19. One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 82.0 percent to the FOMC keeping its target range for the federal funds rate unchanged at the current range of 4.25 percent to 4.50 percent at the March meeting. Investors assign a probability of only 18.0 percent to the committee cutting its target range by 25 basis points at that meeting.

Headline CPI Inflation Is Higher in December but Core Inflation Is Lower than Expected

Image generated by GTP-4o illustrating inflation

On January 15, the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the green line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous month, was 2.9 percent in December—up from 2.7 percent in November.
The core inflation rate, which excludes the prices of food and energy, was 3.2 percent in December—down from 3.3 percent in November.

Headline inflation was slightly above and core inflation was slightly below what economists surveyed had expected.

In the following figure, 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. Calculated as the 1-month inflation rate, headline inflation (the blue line) jumped from 3.8 percent in November to 4.8 percent in December. Core inflation (the green line) decreased from 3.8 percent in November to 2.7 percent in December.

Overall, considering 1-month and 12-month inflation together, the most favorable news is the low value of the 1-month core inflation rate. The most concerning news is a sharp increase in 1-month headline inflation, which brought that measure to its highest reading since February 2024. On balance, this month’s CPI report doesn’t do much to challenge the conclusion of other recent inflation reports that progress on lowering inflation has slowed or, possibly, stalled. So, the probability of a “no landing” outcome, with inflation remaining above the Fed’s target for an indefinite period, seems to have at least slightly increased.

Of course, it’s important not to overinterpret the data from a single month. The figure shows that 1-month inflation is particularly volatile. Also note that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI, to evaluate whether it is hitting its 2 percent annual inflation target.

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the Fed’s policymaking Federal Open Market Committee (FOMC) have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or a house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included in the CPI to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter, and the red line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but in December it was still high at 4.6 percent. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—fell from 4.1 percent in November to 3.1 percent in December.

To better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

Median inflation 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.
Trimmed mean inflation drops the 8 percent of goods and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.

The following figure shows that 12-month median inflation (the red line) declined slightly from 3.9 percent in November to 3.8 percent in December. Twelve-month trimmed mean inflation (the blue line) was unchanged at 3.2 percent for the fifth month in a row.

The following figure shows 1-month median and trimmed mean inflation. One-month median inflation rose from 2.8 percent in November to 3.6 percent in December. One-month trimmed mean inflation fell slightly from 3.3 percent in November to 3.2 percent in December. These data provide confirmation that (1) CPI inflation at this point is likely running higher than a rate that would be consistent with the Fed achieving its inflation target, and (2) that progress toward the target has slowed.

What are the implications of this CPI report for the actions the FOMC may take at its next meeting on January 28-29? The stock market rendered a quick verdict, as the following figure from the Wall Street Journal shows. As soon as the market opened on Wednesday morning, all three of the most widely followed stock market indexes jumped—as indicated by the vertical segments in the figure. Investors seem to be focusing on core CPI inflation being lower than expected, which should increase the probability that the FOMC will cut its target for the federal funds rate at either its March or May meeting. Lower inflation and lower interest rates would be good news for stock prices.

Investors who buy and sell federal funds futures contracts still do not expect that the FOMC will cut its target for the federal funds rate at its next meeting, as indicated by the following figure. (We discuss the futures market for federal funds in this blog post.) Today, investors assign a probability of 93.7 percent to the FOMC leaving its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent at its January 28-29 meeting, and a probability of only 2.7 percent to the committee cutting its target range by 0.25 percentage point (25 basis points).

Unexpectedly Strong Jobs Report

Last September the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) cut its target for the federal funds rate by 0.50 percentage point (50 basis points. Many economists and policymakers expected the FOMC to continue cutting its federal funds rate target at meetings through 2025. (We discussed the September target cut in this blog post.) The FOMC cut its target by 25 basis points at both its November and December 2024 meetings. But by the December meeting, it had become clear that the inflation rate was not falling as quickly to the Fed’s 2 percent target as the committee members had hoped. As FOMC’s staff economists put it, there had been “upward surprises” in inflation data. According to the minutes of the December meeting, several members of the committee believed that “upside risks to the inflation outlook had increased.”

As a result, it seemed likely that the FOMC would leave its target for the federal funds rate unchanged at its next meeting on January 28-29. This conclusion was reinforced this morning (January 10) when the Bureau of Labor Statistics (BLS) released its “Employment Situation” report (often called the “jobs report”) for December. The report indicates that the labor market is stronger than expected.

Economists who had been surveyed by the Wall Street Journal had forecast that payroll employment, as reported in the establishment survey, would increase by 155,000. The BLS reported that payroll employment in December had increased by 256,000, well above expectations. The unemployment rate—which is calculated from data in the household survey—was 4.1 percent, down slightly from 4.2 percent in November. The following figure, taken from the BLS report, shows the net changes in employment for each month during the past two 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 from the establishment survey. The net change in jobs as measured by the household survey for December also showed a strong increase of 478,000 jobs following a decline of 273,000 jobs in November. In any particular month, the story told by the two surveys can be inconsistent with employment increasing in one survey while falling in the other. But in December the two surveys were sending the same signal of rapid employment growth. (In this blog post, we discuss the differences between the employment estimates in the household survey and the employment estimates in the establishment survey.)

The employment-population ratio for prime age workers—those aged 25 to 54—also increased, as shown in the following figure, to 80.5 percent in December from 80.4 percent in November. Although the employment-population is below its recent high of 80.9 percent, it remains high relative to levels seen since 2001.

As the following figure shows, the unemployment rate, which is also reported in the household survey, decreased slightly to 4.1 percent in December from 4.2 percent in November. The unemployment rate has been remarkably stable over the past two years, varying only 0.2 percentage point above or below 4.0 percent.

The establishment survey also includes data on average hourly earnings (AHE). As we noted in this 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 shows the percentage change in the AHE from the same month in the previous year. The AHE increased 3.9 percent in December, down slightly from 4.0 percent in November.

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 wage 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 December 1-month rate of wage inflation was 3.4 percent, a decline from the 4.9 percent rate in November. Whether measured as a 12-month increase or as a 1-month increase, AHE is still increasing somewhat more rapidly than is consistent with the Fed achieving its 2 percent target rate of price inflation.

Given these data from the jobs report, it seems unlikely that the FOMC will reduce its target range for the federal funds rate at its next meeting. One indication of expectations of future rate cuts comes from investors who buy and sell federal funds futures contracts. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, today these investors assign a probability of 97.3 percent to the FOMC keeping its target range for the federal funds rate unchanged at the current range of 4.25 percent to 4.50 percent, at its next meeting. Investors assign a probability of only 2.7 percent of the committee cutting its target range by 25 basis points at that meeting.

As the following figure shows, investors also expect the FOMC to keep its target range unchanged at its meeting on March 18-19, although there is greater uncertainty. Investors assign:

A 74.0 percent probability that the FOMC keeps its target range for the federal funds rate unchanged
A 25.4 percent probability that the committee cuts its target range by 25 basis points
A 0.6 percent probability that the committee cuts its target range by 50 basis points

Why Were Glenn and Tony Particularly Happy in 2024?

Because inflation in chocolate chip cookie prices ended, or course! In December 2023, the average retail price of a pound of chocolate chip cookies (even we try not to eat a pound of cookies in one sitting!) was $5.12. In November 2024, the price had declined to $4.92 per pound. As the following figure shows, the days of 20 percent annual inflation in chocolate chip cookie inflation that lasted from September 2022 to April 2023 are behind us—at least for now.

The following figure shows annual inflation in overall food prices as measured by the percentage change in the food component of the consumer price index (CPI) from the same month in the previous year. During 2024, food inflation has been running at an annual rate of between 2.0 percent and 2.5 percent. In contrast, chocolate chip cookies actually experienced deflation of –1.1 percent. So, the price of chocolate chip cookies relative to the prices of other food products declined by more than did the absolute price.

We were led to contemplate chocolate chip cookie prices by this article in the New York Times that discusses the FRED data set. (A subscription may be required to access the article.) Like many other economists, we heavily use the FRED site and greatly appreciate the efforts of those at the Federal Reserve Bank of St. Louis who have made this data resource available.

New PCE Data Show Inflation Slowing

Image generated by GTP-4o of people shopping.

As we discussed in this blog post on Wednesday, the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) voted to reduce its target for the federal funds rate by 0.25 percentage point. After the meeting, the committee released its “Summary of Economic Projections” (SEP). The SEP showed that the committee’s forecasts of the inflation rate as measured by the personal consumption expenditures (PCE) price index for this year and next year are both higher than the committee had forecast in September, when the last SEP was released. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target.

This morning (December 20), the BEA released monthly data on the PCE price index as part of its “Personal Income and Outlays” report for November.

The following figure shows PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2016 with inflation measured as the percentage change in the PCE from the same month in the previous year. Measured this way, in November PCE inflation was 2.4 percent, up from 2.3 percent in October. Core PCE inflation in November was 2.8 percent, unchanged from October. Both PCE inflation and core PCE inflation were slightly lower than the expectations of economists surveyed before the data were released.

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 fell sharply in November to 1.5 percent from 2.8 percent in October. Core PCE inflation also fell from 3.2 percent in October to 1.4 percent in November. Although both 12-month PCE inflation and 12-month core PCE inflation remained above the Fed’s 2 percent annual inflation target, 1-month PCE inflation and 1-month core PCE inflation dropped to well below the inflation target. But the usual caution applies that data from one month shouldn’t be overly relied on; it’s far too soon to draw the conclusion that inflation is likely to remain below the 2 percent target in future months.

Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University as another way of measuring the underlying trend in inflation. If we listed the inflation rate for each individual good or service included in the PCE, 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 following figure from the Federal Reserve Bank of Cleveland includes, along with PCE inflation (the green line) and core PCE inflation (the blue line), median PCE inflation (the orange line). All three inflation rates are measured over 12 months. Median PCE inflation in November was 3.1 percent, unchanged from October.

In his press conference earlier this week, Fed Chair Jerome Powell noted that: “we’ve had recent high readings from non-market services.” Non-market services are services whose prices the BEA imputes rather than measures directly. For instance, the BEA assumes that prices of financial services—such as brokerage fees—vary with the prices of financial assets. So that if stock prices rise, the prices of financial services included in the PCE price index also rise. Powell argued that these imputed prices “don’t really tell us much about … tightness in the economy. They don’t really reflect that.” The following figure shows 12-month inflation (the blue line) and 1-month inflation (the red line) for market-based PCE, excluding the prices of food and energy. (The BEA explains the market-based PCE measure here.)

These measures of inflation tell a similar story to the measures considered earlier: 12-month inflation continues to run above the Fed’s 2 percent inflation target, while 1-month inflation slowed significantly in November and is below the 2 percent target. By this measure 12-month inflation was unchanged in November at 2.4 percent, while 1-month inflation declined from 2.5 percent in October to 1.4 percent in November.

To summarize, the less volatile 12-month measures of inflation show it to be persistently above the Fed’s target, while the more volatile 1-month measures show inflation to have fallen below target. If the FOMC were to emphasize the 1-month measures, we might expect them to continue cutting the target for the federal funds rate at the committee’s next meeting on January 28-29. The more likely outcome is that, unless other macroeconomic data that are released between now and that meeting indicate a significant strengthening or weakening of the economy, the committee will leave its target for the federal funds rate unchanged. (The BEA’s next release of monthly PCE data won’t occur until January 31, which is after the FOMC meeting.)

Investors who buy and sell federal funds futures contracts expect that the FOMC will leave its federal funds rate target unchanged at its next meeting. (We discuss the futures market for federal funds in this blog post.) As shown in the following figure, investors assign a probability of 91.4 percent to the FOMC leaving its target for the federal funds rate at the current range of 4.25 percent to 4.50. Investors assign a probability of only 8.6 percent to the FOMC cutting its target by 0.25 percentage point.

As Expected, FOMC Cuts Target for the Federal Funds Rate by 0.25 Percentage Point

Federal Reserve Chair Jerome Powell speaks at a press conference following a meeting of the Federal Open Market Committee. (Photo from federalreserve.gov)

Members of the Fed’s Federal Open Market Committee (FOMC) had signaled that the committee was likely to cut its target range for the federal funds rate by 0.25 percentage point (25 basis points) at its meeting today (December 18). As we noted in this recent post, investors had overwhelming expected a cut of this size. Although the committee followed through with a 25 basis point cut, Fed Chair Jerome Powell noted in a press conference following the meeting that it was a “closer call” than were the two earlier cuts this year. The statement the committee released after the meeting showed that only one member—Beth M. Hammack, president of the Federal Reserve Bank of Cleveland—ended up voting against the decision to cut the target rate.

In his press conference, Powell noted that although there were some indications that the labor market has weakened, the committee believed that unemployment was likely to remain near the natural rate. The committee also saw real GDP increasing at a steady rate. Powell stated that he was optimistic about the economy and that “I expect another good year next year.” The main obstacle to the committee fulfilling its dual mandate for full employment and price stability is that inflation remains persistently above the Fed’s target of a 2 percent annual inflation rate.

After the meeting, the committee also released a “Summary of Economic Projections” (SEP)—as it typically does at its March, June, September, and December meetings. The SEP presents median values of the committee members’ forecasts of key economic variables. The values are summarized in the following table, reproduced from the release.

The forecasts mirror the points that Powell made in his news conference:

Committee members now forecast that GDP will be higher in 2024, and that the unemployment rate will be lower, than they had forecast in September.
Committee members now forecast that both personal consumption expenditures (PCE) price inflation and core PCE inflation will be slightly higher in 2024 than they had forecast in September.
Most notably, whereas in September committee members had forecast that PCE inflation would be 2.1 percent in 2025, they now forecast it will be 2.5 percent—notably higher. And committee members now forecast that inflation will not fall to the Fed’s 2 percent target until 2027, rather than 2026.
Finally, committee members now project that the federal funds rate will end 2025 50 basis points lower than it is now, rather than 100 basis points lower. In other words, committee members ares now forecasting only two 25 basis point cuts in the target next year rather than the four cuts they had forecast in September.

In his press conference, Powell noted that the main reason that PCE inflation remains high is that inflation in the prices of housing services has been running high, as have the prices of some other services. Noting that monetary policy affects the economy “with long and variable lags,” Powell stated that he believes that inflation is still on track to fall to the 2 percent target.

Given that inflation has been running closer to 2.5 percent and that the committee expects the inflation rate will still be 2.5 percent next year, a reporter asked Powell if the committee had considered the possibility of accepting a 2.5 percent inflation rate in the long run. Powell replied that: “No. We’re not going to settle for [2.5 percent inflation].” He stated that a 2 percent inflation rate is what the Fed “owes the public.”

Finally, Powell indicated that the committee would have to take into account the effects of the incoming Trump Administration’s fiscal policy actions—particularly tariff increases—when they occur. President Trump has stated that he would like to see interest rates decline more quickly, so the committee may face criticism for keeping the target for the federal funds rate higher next year than they had originally intended.

As Expected, CPI Inflation Is Higher in November as the Fed Struggles to Hit Its Inflation Target.

Image generated by GTP-4o illustrating inflation.

On December 11, the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the red line).

The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous month, was 2.7 percent—up from 2.6 percent in October.
The core inflation rate, which excludes the prices of food and energy, was unchanged at 3.3 percent for the fourth month in a row.

Both headline inflation and core inflation were the same as economists surveyed by the Wall Street Journal had expected.

In the following figure, 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. Calculated as the 1-month inflation rate, headline inflation (the blue line) increased sharply from 3.0 percent in October to 3.8 percent in November. Core inflation (the red line) increased from 3.4 percent in October to 3.8 percent in November.

Overall, considering 1-month and 12-month inflation together, the U.S. economy may still be on course for a soft landing—with the annual inflation rate returning to the Fed’s 2 percent target without the economy being pushed into a recession. However, progress on lowering inflation has slowed or, possibly, stalled. So, the probability of a “no landing” outcome, with inflation remaining above the Fed’s target for an indefinite period, seems to have increased.

The relatively high rates of core inflation in both the 12-month and 1-month measures are concerning because most economists believe that core inflation is a better indicator of the underlying inflation rate than is headline inflation. It’s important not to overinterpret the data from a single month, although this is the fourth month in a row that core inflation has been above 3 percent. (Note, that 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.)

As we’ve discussed in previous blog posts, Federal Reserve Chair Jerome Powell and his colleagues on the Fed’s policymaking Federal Open Market Committee (FOMC) have been closely following inflation in the price of shelter. The price of “shelter” in the CPI, as explained here, includes both rent paid for an apartment or house and “owners’ equivalent rent of residences (OER),” which is an estimate of what a house (or apartment) would rent for if the owner were renting it out. OER is included in the CPI to account for the value of the services an owner receives from living in an apartment or house.

As the following figure shows, inflation in the price of shelter has been a significant contributor to headline inflation. The blue line shows 12-month inflation in shelter, and the red line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but in November it was at a still high 4.8 percent. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—fell from 4.7 percent in October to 4.1 percent in November.

To better estimate of the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.

Median inflation 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.
Trimmed mean inflation drops the 8 percent of good and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.

The following figure is from the Federal Reserve Bank of Cleveland. It shows that median inflation (the orange line) fell from 4.1 percent in October to 3.9 percent in November. Trimmed mean inflation (the blue line) was unchanged at 3.2 percent for the fourth month in a row. These data provide confirmation that (1) core CPI inflation at this point is likely running higher than a rate that would be consistent with the Fed achieving its inflation target, and (2) that progress toward the target has slowed.

Will this persistence in inflation above the Fed’s 2 percent target cause the FOMC to hold constant its target range for the federal funds rate? Investors who buy and sell federal funds futures contracts still expect that the FOMC will cut its target for the federal funds rate by 0.25 percentage point at its next meeting on December 17-18. (We discuss the futures market for federal funds in this blog post.) The following figure shows that today these investors assign a probability of 94.7 percent to the FOMC cutting its target for the federal funds rate by 0.25 percentage point and a probability of only 5.3 percent to the committee leaving its target unchanged at its current range of 4.50 percent to 4.75 percent.