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Latest CPI Report Shows Slowing Inflation and the FOMC Appears Likely to Cut Its Target for the Federal Funds Rate at Least Once This Year

Image of “a woman shopping in a grocery store” generated by ChatGTP 4o.

Today (June 12) we had the unusual coincidence of the Bureau of Labor Statistics (BLS) releasing its monthly report on the consumer price index (CPI) on the same day that the Federal Open Market Committee (FOMC) concluded a meeting. The CPI report showed that the inflation rate had slowed more than expected. As the following figure shows, the inflation rate for May measured by the percentage change in the CPI from the same month in the previous month—headline inflation (the blue line)—was 3.3 percent—slightly below the 3.4 percent rate that economists surveyed by the Wall Street Journal had expected, and slightly lower than the 3.4 percent rate in April. Core inflation (the red line(—which excludes the prices of food and energy—was 3.4 percent in May, down from 3.6 percent in April and slightly lower than the 3.5 percent rate that economists had been expecting.

As the following figure shows, 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 much larger. Headline inflation (the blue line) declined from 3.8 percent in April to 0.1 percent in May. Core inflation (the red line) declined from 3.6 percent in April to 2.0 percent in May. Overall, we can say that inflation has cooled in May and if inflation were to continue at the 1-month rate, the Fed will have succeeded in bringing the U.S. economy in 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.

But two important notes of caution:

1. It’s hazardous to rely to heavily on data from a single month. Over the past year, the BLS has reported monthly inflation rates that were higher than economists expected and rates that was lower than economists expected. The current low inflation rate would have to persist over at least a few more months before we can safely conclude that the Fed has achieved a safe landing.

2. 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. So, today’s encouraging CPI data would have to carry over to the PCE data that the Bureau of Economic Analysis (BEA) will release on January 28 before we can conclude that inflation as the Fed tracks it did in fact slow significantly in April.

The BLS released the CPI report at 8:30 am eastern time. The FOMC began its meeting later in the day and so committee members were able to include in their deliberations today’s CPI data along with other previously available information on the state of the economy. At the close of the meeting, , the FOMC released a statement in which it stated, as expected, that it would leave its target range for the federal funds rate unchanged at 5.25 percent to 5.50 percent. After the meeting, the committee also released—as it typically does at its March, June, September, and December meetings—a “Summary of Economic Projections” (SEP), which 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 table shows that compared with their projections in March—the last time the FOMC published the SEP—committee members were expecting higher headline and core PCE inflation and a higher federal funds rate at the end of this year. In the long run, committee members were expecting a somewhat highr unemployment rate and somewhat higher federal funds rate than they had expected in March.

Note, as we discuss in Macreconomics, Chapter 14, Section 14.4 (Economics, Chapter 24, Section 24.4 and Essentials of Economics, Chapter 16, Section 16.4), there are twelve voting members of the FOMC: the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and presidents of four of the other 11 Federal Reserve Banks, who serve one-year rotating terms. In 2024, the presidents of the Richmond, Atlanta, San Francisco, and Cleveland Feds are voting members. The other Federal Reserve Bank presidents serve as non-voting members, who participate in committee discussions and whose economic projections are included in the SEP.

Prior to the meeting there was much discussion in the business press and among investment analysts about the dot plot, shown below. Each dot in the plot represents the projection of an individual committee member. (The committee doesn’t disclose which member is associated with which dot.) Note that there are 19 dots, representing the 7 members of the Fed’s Board of Governors and all 12 presidents of the Fed’s district banks.

The plots on the far left of the figure represent the projections of each of the 19 members of the value of the federal funds rate at the end of 2024. Four members expect that the target for the federal funds rate will be unchanged at the end of the year. Seven members expect that the committee will cut the target range once, by 0.25 percentage point, by the end of the year. And eight members expect that the cut target range twice, by a total of 0.50 percent point, by the end of the year. Members of the business media and financial analysts were expecting tht the dot plot would project either one or two target rate cuts by the end of the year. The committee was closely divided among those two projections, with the median projection being for a single rate cut.

In its statement following the meeting, the committee noted that:

“In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage‐backed securities. The Committee is strongly committed to returning inflation to its 2 percent objective.”

In his press conference after the meeting, Fed Chair Jerome Powell noted that the morning’s CPI report was a “Better inflation report than nearly anyone expected.” But, Powell also noted that: “You don’t want to be motivated any one data point.” Reinforcing the view quoted above in the committee’s statement, Powell emphasized that before cutting the target for the federal funds rate, the committee would need “Greater confidence that inflation is moving back to 2% on a sustainable basis.”

In summary, today’s CPI report was an indication that the Fed is on track to bring about a soft landing, but the FOMC will be closely analyzing macroeconomic data over at least the next few months before it is willing to cut its target for the federal funds rate.

Solved Problem: The Fed and the Value of Money

Supports: Macroeconomics, Chapter 15, Economics, Chapter 25, Essentials of Economics, Chapter 17, and Money, Banking, and the Financial System, Chapter 15.

Image generated by ChatGTP-4o.

In a book review in the Wall Street Journal, the financial writer James Grant referred to “the Federal Reserve’s goal to cheapen the dollar by 2% a year.”

Briefly explain what “cheapen the dollar” means.
Briefly explain what Grant means by writing that the Fed has a “goal to cheapen the dollar by 2% a year.”
Do you agree with Grant that the Fed has this goal? Briefly explain.

Solving the Problem
Step 1: Review the chapter material. This problem is about the economic effects of the Federal Reserve’s policy goal of a 2 percent annual inflation rate, so you may want to review Chapter 15, Section 15.5, “A Closer Look at the Fed’s Setting Monetary Policy Targets.”

Step 2: Answer part a. by explaining what “cheapen the dollar” means. Judging from the context, “cheapen the dollar” means to reduce the purchasing power of a dollar. Whenever inflation occurs, the amount of goods and services a dollar can purchase declines. If the inflation rate in a year is 10 percent, than at the end of the year $1,000 can buy 10 percent fewer goods and services than it could at the beginning of the year.

Step 3: Answer part b. by expalining what Grant means by the Fed having a goal of cheapening the dollar by 2 percent a year. Congress has given a dual mandate of high employment and price stability. Since 2012, the Fed has interpreted a 2 percent annual inflation rate as meeting its mandate for price stability. So, Grant means that the Fed’s 2 percent annual inflation goal in effect is also a goal to cheapen—or reduce the purchasing power of the dollar—by 2 percent a year.

Step 4: Answer part c. by explaining whether you agree with Grant that the Fed has a goal of cheapening the dollar by 2 percent a year. As explained in the answer to part b., there is a sense in which Grant is correct; the Fed’s goal of a 2 percent inflation rate is a goal of allowing the purchasing power of the dollar to decline by 2 percent a year. One complication, however, is that most economists believe that changes in price indexes such as the consumer price index (CPI) and the personal consumption expenditures (PCE) price index overstate the actual amount of inflation occurring in the economy. As we discuss in Macroeconomics, Chapter 9, Section 9.4 (Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 13, Section 13.4), there are several biases that cause price indexes to overstate the true inflation rate; the most important of the biases is the failure of price indexes to take fully into account improvements over time in the quality of many goods and services. If increases in price indexes are overstating the inflation rate by one percentage point, then the Fed’s goal of a 2 percent inflation rate results in the dollar losing 1 percent—rather than 2 percent—of its purchasing power over time, corrected for changes in quality.

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,”

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.

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 Steady-as-She-Goes FOMC Meeting

Federal Reserve Chair Jerome Powell (Photo from the New York Times)

As always, economists and investors had been awaiting the outcome of today’s meeting of the Federal Reserve’s policy-making Federal Open Market Committee (FOMC) to get further insight into future monetary policy. The expectation has been that the FOMC would begin reducing its target for the federal funds rate, mostly likely beginning with its meeting on June 11-12. Financial markets were expecting that the FOMC would make three 0.25 percentage point cuts by the end of the year, reducing its target range from the current 5.25 to 5.50 percent to 4.50 to 4.75 percent.

There appears to be nothing in the committees statement (found here) or in Powell’s press conference following the meeting to warrant a change in expectations of future Fed policy. The committee’s statement noted that: “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” As Powell stated in his press conference, although the committee found the general trend in inflation data to be encouraging, they would have to see additional months of data that were consistent with their 2 percent inflation target before reducing their target for the federal funds rate.

As we’ve noted in earlier blog posts (here, here, and here), inflation during January and February has been somewhat higher than expected. Some economists and investors had wondered if, as a result, the committee might delay its first cut in the federal funds target range or implement only two cuts rather than three. In his press conference, Powell seemed unconcerned about the January and February data and expected that falling inflation rates of the second half of 2023 to resume.

Typically, at the FOMC’s December, March, June, and December meetings, the committee releases a “Summary of Economic Projections” (SEP), which presents median values of the committee members’ forecasts of key economic variables.

The table shows that the committee members made relatively small changes to their projections since their December meeting. Most notable was an increase in the median projection of growth in real GDP for 2024 from 1.4 percent at the December meeting to 2.1 percent at this meeting. Correspondingly, the median projection of unemployment during 2024 dropped from 4.1 percent to 4.0 percent. The key projection of the value of the federal funds rate at the end of 2024 was left unchanged at 4.6 percent. As noted earlier, that rate is consistent with three 0.25 percent cuts in the target range during the remainder of the year.

The SEP also includes a “dot plot.” Each dot in the plot represents the projection of an individual committee member. (The committee doesn’t disclose which member is associated with which dot.) Note that there are 19 dots, representing the 7 members of the Fed’s Board of Governors and the 12 presidents of the Fed’s district banks. Although only the president of the New York Fed and the presidents of 4 of the 11 district banks are voting members of the committee, all the district bank presidents attend the committee meetings and provide economic projections.

The plots on the far left of the figure represent the projections of each of the 19 members of the value of the federal funds rate at the end of 2024. These dots are bunched fairly closely around the median projection of 4.6 percent. The dots representing the projections for 2025 and 2026 are more dispersed, representing greater uncertainty among committee members about conditions in the future. The dots on the far right represent the members’ projections of the value of the federal funds rate in the long run. As Table 1 shows, the median projected value is 2.6 percent (up slightly from 2.5 percent in December), although the plot indicates that all but one member expects that the long-run rate will be 2.5 percent or higher. In other words, few members expect a return to the very low federal funds rates of the period from 2008 to 2016.

Key Macro Data Series during the Time Since the Arrival of Covid–19 in the United States

A bookstore in New York City closed during Covid. (Photo from the New York Times)

Four years ago, in mid-March 2020, Covid–19 began to significantly affect the U.S. economy, with hospitalizations rising and many state and local governments closing schools and some businesses. In this blog post we review what’s happened to key macro variables during the past four years. Each monthly series starts in February 2020 and the quarterly series start in the fourth quarter of 2019.

Production

Real GDP declined by 5.8 percent from the fourth quarter of 2019 to the first quarter of 2020 and by an additional 28.0 percent from the first quarter of 2020 to the second quarter. This decline was by far the largest in such a short period in the history of the United States. From the second quarter to the third quarter of 2020, as businesses began to reopen, real GDP increased by 34.8 percent, which was by far the largest increase in a single quarter in U.S. history.

Industrial production followed a similar—although less dramatic—path to real GDP, declining by 16.8 percent from February 2020 to April 2020 before increasing by 12.3 percent from April 2020 to June 2020. Industrial production did not regain its February 2020 level until March 2022. The swings in industrial production were smaller than the swings in GDP because industrial production doesn’t include the output of the service sector, which includes firms like restaurants, movie theaters, and gyms that were largely shutdown in some areas. (Industrial production measures the real output of the U.S. manufacturing, mining, and electric and gas utilities industries. The data are issued by the Federal Reserve and discussed here.)

Employment

Nonfarm payroll employment, collected by the Bureau of Labor Statistics (BLS) in its establishment survey, followed a path very similar to the path of production. Between February and April 2020, employment declined by an astouding 22 million workers, or by 14.4 percent. This decline was by far the largest in U.S. history over such a short period. Employment increased rapidly beginning in April but didn’t regain its February 2020 level until June 2022.

The employment-population ratio measures the percentage of the working-age population that is employed. It provides a more comprehensive measure of an economy’s utilization of available labor than does the total number of people employed. In the following figure, the blue line shows the employment-population ratio for the whole working-age population and the red line shows the employment-population ratio for “prime age workers,” those aged 25 to 54.

For both groups, the employment-population ratio plunged as a result of Covid and then slowly recovered as the production began increasing after April 2020. The employment-population ratio for prime age workers didn’t regain its February 2020 value until February 2023, an indication of how long it took the labor market to fully overcome the effects of the pandemic. As of February 2024, the employment-population ratio for all people of working age hasn’t returned to its February 2020 value, largely because of the aging of the U.S. population.

Average weekly hours worked followed an unusual pattern, declining during March 2020 but then increasing to beyond its February 2020 level to a peak in April 2021. This increase reflects firms attempting to deal with a shortage of workers by increasing the hours of those people they were able to hire. By April 2023, average weekly hours worked had returned to its February 2020 level.

Income

Real average hourly earnings surged by more than six percent between February and April 2020—a very large increase over a two-month period. But some of the increase represented a composition effect—as workers with lower incomes in services industries such as restaurants were more likely to be out of work during this period—rather than an actual increase in the real wages received by people employed during both months. (Real average hourly earnings are calculated by dividing nominal average hourly earnings by the consumer price index (CPI) and multiplying by 100.)

Median weekly real earnings, because it is calculated as a median rather than as an average (or mean), is less subject to composition effects than is real average hourly earnings. Median weekly real earnings increased sharply between February and April of 2020 before declining through June 2022. Earnings then gradually increased. In February 2024 they were 2.5 percent higher than in February 2020.

Inflation

The inflation rate most commonly mentioned in media reports is the percentage change in the CPI from the same month in the previous year. The following figure shows that inflation declined from February to May 2020. Inflation then began to rise slowly before rising rapidly beginning in the spring of 2021, reaching a peak in June 2022 at 9.0 percent. That inflation rate was the highest since November 1981. Inflation then declined steadily through June 2023. Since that time it has fluctuated while remaining above 3 percent.

As we discuss in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5), the Federal Reserve gauges its success in meeting its goal of an inflation rate of 2 percent using the personal consumption expenditures (PCE) price index. The following figure shows that PCE inflation followed roughly the same path as CPI inflation, although it reached a lower peak and had declined below 3 percent by November 2023. (A more detailed discussion of recent inflation data can be found in this post and in this post.)

Monetary Policy

The following figure shows the effective federal funds rate, which is the rate—nearly always within the upper and lower bounds of the Fed’s target range—that prevails during a particular period in the federal funds market. In March 2020, the Fed cut its target range to 0 to 0.25 percent in response to the economic disruptions caused by the pandemic. It kept the target unchanged until March 2022 despite the sharp increase in inflation that had begun a year earlier. The members of the Federal Reserve’s Federal Open Market Committee (FOMC) had initially hoped that the surge in inflation was largely caused by disuptions to supply chains and would be transitory, falling as supply chains returned to normal. Beginning in March 2022, the FOMC rapidly increased its target range in response to continuing high rates of inflation. The targer range reached 5.25 to 5.50 percent in July 2023 where it has remained through March 2024.

Although the money supply is no longer the focus of monetary policy, some economists have noted that the rate of growth in the M2 measure of the money supply increased very rapidly just before the inflation rate began to accelerate in the spring of 2021 and then declined—eventually becoming negative—during the period in which the inflation rate declined.

As we discuss in the new 9th edition of Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5), some economists believe that the FOMC should engage in nominal GDP targeting. They argue that this approach has the best chance of stabilizing the growth rate of real GDP while keeping the inflation rate close to the Fed’s 2 percent target. The following figure shows the economy experienced very high rates of inflation during the period when nominal GDP was increasing at an annual rate of greater than 10 percent and that inflation declined as the rate of nominal GDP growth declined toward 5 percent, which is closer to the growth rates seen during the 2000s. (This figure begins in the first quarter of 2000 to put the high growth rates in nominal GDP of 2021 and 2022 in context.)

Fiscal Policy

As we discuss in the new 9th edition of Macroeconomics, Chapter 15 (Economics, Chapter 25), in response to the Covid pandemic Congress and Presidents Trump and Biden implemented the largest discretionary fiscal policy actions in U.S. history. The resulting increases in spending are reflected in the two spikes in federal government expenditures shown in the following figure.

The initial fiscal policy actions resulted in an extraordinary increase in federal expenditures of $3.69 trillion, or 81.3 percent, from the first quarter to the second quarter of 2020. This was followed by an increase in federal expenditures of $2.31 trillion, or 39.4 percent, from the fourth quarter of 2020 to the first quarter of 2021. As we recount in the text, there was a lively debate among economists about whether these increases in spending were necessary to offest the negative economic effects of the pandemic or whether they were greater than what was needed and contributed substantially to the sharp increase in inflation that began in the spring of 2021.

Saving

As a result of the fiscal policy actions of 2020 and 2021, many households received checks from the federal government. In total, the federal government distributed about $80o billion directly to households. As the figure shows, one result was to markedly increase the personal saving rate—measured as personal saving as a percentage of disposable personal income—from 6.4 percent in December 2019 to 22.0 in April 2020. (The figure begins in January 2020 to put the size of the spike in the saving rate in perspective.)

The rise in the saving rate helped households maintain high levels of consumption spending, particularly on consumer durables such as automobiles. The first of the following figure shows real personal consumption expenditures and the second figure shows real personal consumption expenditures on durable goods.

Taken together, these data provide an overview of the momentous macroeconomic events of the past four years.

Do ATMs that Dispense Gold Rather Than Currency Make Economic Sense?

An Automated Teller Machine (ATM) located in Egypt that dispenses gold bars rather than currency. (Photo from ahrm.org.)

A recent article in the New York Times (available here, but a subscription may be required) discusses how consumers in Egypt are dealing with inflation. According to statistics from the International Monetary Fund, consumer prices in Egypt rose 23.5 percent in 2023 and are projected to increase by 32.2 percent in 2024, although in early 2024 inflation may have been running at an annual rate of 50 percent. In response to the inflation, many Egyptian businesses have begun quoting prices in U.S. dollars rather than in Egyptian pounds. The value of the Egyptian pound has declined from about 18 pounds to the U.S. dollar in early 2022 to about 48 pounds to the dollar today. In practice, many Egyptian consumers can have difficulty obtaining dollars except on the black market, where the exchange rate is generally worse than the rate quoted by the Egyptian central bank.

According to the article, many Egyptians, losing faith in value of the pound and unable to easily obtain U.S. dollars, have turned to gold as a potentially “safe financial harbor.” The article notes that: “The market [for gold] grew so fevered that the government announced in November that it was partnering with a financial technology company to install A.T.M.s [Automated Teller Machines] that would dispense gold bars instead of cash.” That ATM is shown in the photo above.

This episode raises two questions:

Is gold a good hedge (a “safe harbor”) against inflation?
Are ATMs that dispense gold rather than currency a good idea?

As we discuss in Chapter 14, Section 14.3 of Money, Banking, and the Financial System, gold has not been a good hedge against inflation for U.S. investors. Although many people believe that the price of gold can be relied on to increase if the general price level increases, in fact, the data show that the price of gold can’t be counted on to keep up with increases in the general price level. In the following figure, the blue line shows the market price of gold during each month since January 1976. The red line shows the real price of gold, which is calculated by dividing the nominal price of gold by the consumer price index (CPI). (For convenience, we set the value of the CPI equal to 100 in January 1976.) The price of gold is measured in dollars per ounce.

The figure shows that the market price of gold can fall even as the price level rises. For example, the price of gold rose from $132 per ounce in January 1976 to $670 per ounce in September 1980. As a result, during that period the real price of gold more than tripled, and holding gold during this period was a good hedge against inflation. Unfortunately, the market price of gold then went into a long decline and didn’t again reach its September 1980 value until April 2007, a period during which the CPI more than doubled. In other words, over this more than 25-year period gold provided no hedge at all against the effects of inflation. Consumers in India today shouldn’t count on buying gold as way to protect the real value of their savings from being reduced by inflation.

The New York Times article refers to only a single ATM in Egypt that dispenses gold bars rather than Egyptian pounds. Would we expect that the number of these ATMs will increase in Egypt and other countries experiencing very high inflation rates? Does the existence of these ATMs indicate that people in Egypt are now—or will likely begin—using gold bars rather than currency for routine buying and selling?

The answer to both questions is likely “no.” Although the article refers to an “ATM,” it might be better to think of this facility as instead being a vending machine. Similar ATMs/vending machines that dispense gold bars are available in the United States (as indicated here, here, and here), and, most likely, in other countries as well.

We usually think of vending machines as selling soda and water or snacks. But there are many vending machines that sell other products as well. For instance, most large airports have vending machines that sell small electronic products, such as cell phone batteris or earphones. The term ATM is usually reserved for machines that enable people who have deposits at a bank or other financial firms to withdraw currency. So, the article seems to be describing something that is more a vending machine than an ATM. The article discusses the many small businesses in Egypt that buy and sell gold, which makes it likely that most consumers will continue to rely on those businesses rather than on a machine when they want to buy and sell gold.

It seems unlikely that people in Egypt will beging using gold bars for routine buying and selling—that is, using gold as a medium of exchange. Most goods in Egypt have their prices denominated in either Egyptian pounds or in U.S. dollars or in both. Anyone attempting to buy goods with gold bars would need first to determine the market price of gold at that time before making the purchase and would have to locate a seller who was willing to accept gold in exchange for their goods. In effect, sellers would be engaging in two transactions at the same time: buying gold from the buyer and selling goods to the buyer. Although in a time of high inflation a seller takes on the risk that currency he accepts for a purchase may decline in value while the seller is holding it, a seller accepting gold also takes on the risk that the market price of gold may fall while the seller is holding it.

It’s interesting that the Egyptian government reacted to consumers buying gold as a hedge against inflation by partnering with a financial firm to make available an “ATM” that dispenses gold bars. But it probably doesn’t represent a significant development in the Egyptian financial system.

Consumer Price Inflation Comes in Somewhat Higher than Expected

Federal Reserve Chair Jerome Powell (Photo from Bloomberg News via the Wall Street Journal.)

Economists, policymakers, and Wall Street analysts have been waiting for macroeconomic data to confirm that the Federal Reserve has brought the U.S. economy in for a soft landing, with inflation arrving back at the Fed’s target of 2 percent without the economy slipping into a recession. Fed officials have been cautious about declaring that they have yet seen sufficient data to be sure that a soft landing has actually been achieved. Accordingly, they are not yet willing to begin cutting their target for the federal funds rate.

For instance, on March 6, in testifying before the Commitee on Financial Services of the U.S. House of Representatives, Fed Chair Jerome Powell stated that the Fed’s Federal Open Market Committee (FOMC) “does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.” (Powell’s statement before his testimony can be found here.)

The BLS’s release today (March 12) of its report on the consumer price index (CPI) (found here) for February indicated that inflation was still running higher than the Fed’s target, reinforcing the cautious approach that Powell and other members of the FOMC have been taking. The increase in the CPI that includes the prices of all goods and services in the market basket—often called headline inflation—was 3.2 percent from the same month in 2023, up slightly from 3.1 In January. (We discuss how the BLS constructs the CPI in Macroeconomics, Chapter 9, Section 19.4, Economics, Chapter 19, Section 19.4, and Essentials of Economics, Chapter 3, Section 13.4.) As the following figure shows, core inflation—which excludes the prices of food and energy—was 3.8 percent, down slightly from 3.9 percent 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 are more concerning, as indicated in the following figure. Headline CPI inflation is 5.4 percent (up from 3.7 percent in January) and core CPI inflation is 4.4 percent (although that is down from 4.8 percent in January). 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.

Even more concerning is the path of inflation in the prices of services. As we’ve noted in earlier posts, Chair 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. Last summer he stated the point this way:

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. Although inflation in service prices declined from January, it was still a very high 5.8 percent in February. Inflation in service prices not including housing rent was even higher at 7.5 percent. 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 February, it was still high at 4.6 percent and, although median inflation is volatile, the trend has been generally upward since July 2023.

The data in this month’s BLS report on the CPI reinforces the view that the FOMC will not move to cut its target for the federal funds rate in the meeting next week and makes it somewhat less likely that the committee will cut its target at the following meeting on April 30-May 1.

The Latest PCE Report and PCE Inflation v. CPI Inflation

Photo courtesy of Lena Buonanno.

Wall Street Journal columnist Justin Lahart notes that when the Bureau of Labor Statistics (BLS) releases its monthly report on the consumer price index (CPI), the report “generates headlines, features in politicians’ speeches and moves markets.” When the Bureau of Economic Analysis (BEA) releases its monthly report “Personal Income and Outlays,” which includes data on the personal consumption expenditures (PCE) price index, there is much less notice in the business press or, often, less effect on financial markets. (You can see the difference in press coverage by comparing the front page of today’s online edition of the Wall Street Journal after the BEA released the latest PCE data with the paper’s front page on February 13 when the BLS released the latest CPI data.)

This difference in the weight given to the two inflation reports seems curious because the Federal Reserve uses the PCE, not the CPI, to determine whether it is achieving its 2 percent annual inflation target. When a new monthly measure of inflation is released much of the discussion in the media is about the effect the new data will have on the Federal Open Market Committee’s (FOMC) decision on whether to change its target for the federal funds rate. You might think the result would be greater media coverage of the PCE than the CPI. (The PCE includes the prices of all the goods and services included in the consumption component of GDP. Because the PCE includes the prices of more goods and services than does the CPI, it’s a broader measure of inflation, which is the key reason that the Fed prefers it.)

That CPI inflation data receive more media discussion than PCE inflation data is likely due to three factors:

The CPI is more familiar to most people than the PCE. It is also the measure that politicians and political commentators tend to focus on. The media are more likely to highlight a measure of inflation that the average reader easily understands rather than a less familiar measure that would require an explanation.
The monthly report on the CPI is typically released about two weeks before the monthly report on the PCE. Therefore, if the CPI measure of inflation turns out to be higher or lower than expected, the stock and bond markets will react to this new information on the value of inflation in the previous month. If the PCE measure is roughly consistent with the CPI measure, then the release of new data on the PCE measure contains less new information and, therefore, has a smaller effect on stock and bond prices.
Over longer periods, the two measures of inflation often move fairly closely together as the following figure shows, although CPI inflation tends to be somewhat higher than PCE inflation. The values of both series are the percentage change in the index from the same month in the previous year.

Turning to the PCE data for January released in the BEA’s latest “Personal Income and Outlays” report, the PCE inflation data were broadly consistent with the CPI data: Inflation in January increased somewhat from December. The first of the following figures shows PCE inflation and core PCE inflation—which excludes energy and food prices—for the period since January 2015 with inflation measured as the change in PCE from the same month in the previous year. The second figure shows PCE inflation and core PCE inflation measured as the inflation rate calculated by compounding the current month’s rate over an entire year. (The first figure shows what is sometimes called 12-month inflation and the second figure shows 1-month inflation.)

The two inflation measures are telling markedly different stories: 12-month inflation shows a continuation in the decline in inflation that began in 2022. Twelve-month PCE inflation fell from 2.6 percent in December to 2.4 percent in January. Twelve-month core PCE inflation fell from 2.9 percent in December to 2.8 percent in December. So, by this measure, inflation continues to approach the Fed’s 2 percent inflation target.

One-month PCE and core PCE inflation both show sharp increases from December to January: From 1.4 percent in December to 4.2 percent for 1-month PCE inflation and from 1.8 percent in December to 5.1 percent in January for 1-month core PCE inflation.

The one-month inflation data are bad news in that they may indicate that inflation accelerated in January and that the Fed is, therefore, further away than it seemed in December from hitting its 2 percent inflation target. But it’s important not to overinterpret a single month’s data. Although 1-month inflation is more volatile than 12-month inflation, the broad trend in 1-month inflation had been downwards from mid-2022 through December 2023. It will take at least a more months of data to assess whether this trend has been broken.

Fed officials didn’t appear to be particularly concerned by the news. For instance, according to an article on bloomberg.com, Federal Reserve Bank of Atlanta President Raphael Bostic noted that: “The last few inflation readings—one came out today—have shown that this is not going to be an inexorable march that gets you immediately to 2%, but that rather there are going to be some bumps along the way.” Investors appear to continue to expect that the Fed will cut its target for the federal funds rate at its meeting on June 11-12.