Tag: Macroeconomics

As Expected, PCE Inflation Slows but Remains above Fed’s Target

Image generated by GTP-4o of people shopping.

Today (February 28), the BEA released monthly data on the personal consumption expenditures (PCE) price index as part of its “Personal Income and Outlays” report.  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 (green 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 January PCE inflation was 2.5 percent, down slightly from 2.6 in December. Core PCE inflation in January was 2.6 percent, down from 2.9 percent in December.  Headline and core PCE inflation were both consistent with the forecasts of economists.

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 January to 4.0 percent from 3.6 percent in December. Core PCE inflation rose in January to 3.5 percent from to 2.5 percent in December. So, both 1-month core PCE inflation estimates are running well above the Fed’s 2 percent target. But the usual caution applies that 1-month inflation figures are volatile (as can be seen in the figure), so we shouldn’t attempt to draw wider conclusions from one month’s data.

In recent months, Fed Chair Jerome Powell has noted that inflation in non-market services has been high. 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 has 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 headline inflation (the blue line) and 12-month core inflation (the green line) for market-based PCE. (The BEA explains the market-based PCE measure here.)

Headline market-based PCE inflation was 2.2 percent in January, and core market-based PCE inflation was 2.3 percent. So, both market-based measures show less inflation in January than do the total measures. In the following figure, we look at 1-month inflation using these measures. Again, inflation is running somewhat lower when using these market-based measures of inflation. Note, though, that all four market-based measures are running above the Fed’s 2 percent target.

In summary, today’s data don’t change the general picture with respect to inflation: While inflation has substantially declined from its high in mid-2022, it still is running above the Fed’s target of 2 percent. As a result, it’s likely 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.

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 the following figure shows, investors assign a probability of 93.5 percent to the FOMC leaving its target for the federal funds rate unchanged at the current range of 4.25 percent to 4.50. Investors assign a probability of only 6.5 percent to the FOMC cutting its target by 0.25 percentage point (25 basis points).

As shown the following figure shows, investors assign a probability of greater than 50 percent that the FOMC will cut its target range by at least 25 basis points at its meeting nearly four months from now on June 17–18. Investors may be concerned that the economy is showing some signs of weakening. Today’s BEA report indicates that real personal consumption expenditures declined at a very high 5.5 percent compound annual rate in January. (Although measured as the 12-month change, real consumption spending increased by 3.o percent in January.)

We’ll have a better understanding of the FOMC’s evaluation of recent macroeconomic data after Chair Powell’s news conference following the March 18–19 meeting.

CPI Inflation in January Is Higher than Expected

Image generated by GTP-4o illustrating inflation

On February 12, 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 dotted 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 3.0 percent in January—up from 2.9 percent in December. 
  • The core inflation rate, which excludes the prices of food and energy, was 3.3 percent in January—up from 3.2 percent in December. 

Headline inflation and core inflation were both above 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 4.5 percent in December to 5.7 percent in January—following a large jump in inflation from November to December. Core inflation (the dotted green line) more than doubled from 2.5 percent in December to 5.5 percent in January.

Overall, considering 1-month and 12-month inflation together, today’s data are concerning. One-month headline inflation is the highest it’s been since August 2023. One-month core inflation is the highest it’s been since April 2023. This month’s CPI report reinforces the conclusion from other recent inflation reports that progress on lowering inflation appears to have 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. 

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 green line shows 1-month inflation in shelter. Twelve-month inflation in shelter has been declining since the spring of 2023, but in January it was still relatively high at 4.4 percent. One-month inflation in shelter—which is much more volatile than 12-month inflation in shelter—rose sharply from 3.3 percent in December to 4.6 percent in January. Clearly a worrying sign given that many economists were expecting that shelter inflation would continue to slow.

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 at 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 trimmed-mean inflation (the blue line) jumped from 3.1 percent in December to 5.2 percent in January. Median inflation (the green line), which had been stable over the past five months, increased from 3.2 percent in December to 3.9 percent in January.

The following figure shows 1-month median and trimmed-mean inflation. One-month trimmed-mean inflation jumped from 3.1 percent in December to 5.1 percent in January. One-month median inflation rose from 3.2 percent in December to 3.9 percent in January. These data provide confirmation that (1) CPI inflation at this point is 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.

Looking at the futures market for federal funds, investors who buy and sell federal funds futures contracts are not expecting that the Fed’s policymaking Federal Open Market Committee (FOMC) will cut its target for the federal funds until this fall. (We discuss the futures market for federal funds in this blog post.) Investors assign a higher probability to the FOMC leaving its target range for the federal funds rate unchanged at 4.25 percent to 4.50 percent at its January, March, June, July, and September meetings. It’s not until the FOMC’s meeting on October 28-29 that, as shown below, investors assign a higher probability to a rate cut than to the committee leaving the rate unchanged.

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.

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.

Glenn on How the Trump Administration Can Hit Its Growth Target

Treasury Secretary nominee Scott Bessent. (Photo from Progect Syndicate.)

By setting an ambitious 3% growth target, U.S. Treasury Secretary nominee Scott Bessent has provided the Trump administration a North Star to follow in devising its economic policies. The task now is to focus on productivity growth and avoiding any unforced errors that would threaten output.

U.S. Treasury Secretary nominee Scott Bessent is right to emphasize faster economic growth as a touchstone of Donald Trump’s second presidency. More robust growth not only implies higher incomes and living standards—surely the basic objective of economic policy—but  also can reduce America’s yawning federal budget deficit and debt-to-GDP ratio, and ease the sometimes difficult trade-offs across defense, social, and education and research spending.

But faster growth must be more than just a wish. Achieving it calls for a carefully constructed agenda, based on a recognition of the channels through which economic policies can raise or reduce output. While a pro-investment tax policy might boost capital accumulation, productivity, and GDP, higher interest rates from deficit-financed tax or spending changes might have the opposite effect. Similarly, since growth in hours worked is a component of growth in output or GDP, the new administration should avoid anti-work policies that hinder full labor-force participation, as well as sudden adverse changes to legal immigration.

While recognizing that some policy shifts that increase output might adversely affect other areas of social interest (such as the distribution of income) or even national security, policymakers should focus squarely on increasing productivity. The three pillars of any productivity policy are support for research, investment-friendly tax provisions, and more efficient regulation.

Ideas drive prospects in modern economies. Basic research in the sciences, engineering, and medicine power the innovation that advances technology, improvements in business organization, and gains in health and well-being. It makes perfect sense for the federal government to support such research. Since private firms cannot appropriate all the gains from their own outlays for basic research, they have less of an incentive to invest in it. Moreover, government support in this area produces valuable spillovers, as demonstrated by the earlier Defense Department research expenditures that became catalysts for today’s digital revolution.

This being the case, cuts in federal support for basic research are inconsistent with a growth agenda. Still, policymakers should review how research funds are distributed to ensure scientific merit, and they should encourage a healthy dose of risk-taking on newer ideas and researchers.

In addition to encouraging commercialization of spillovers from basic research and defense programs, federal support for applied research centers around the country would accelerate the dissemination of new productivity-enhancing technologies and ideas. Such centers also tend to distribute the economy’s prosperity more widely, by making new ideas broadly accessible—as agricultural- and manufacturing-extension services have done historically.

To address the second pillar of productivity growth, the administration should seek to extend the pro-investment provisions of the Tax Cuts and Jobs Act that Trump signed into law in 2017. While the TCJA’s lower tax rates on corporate profits remain in place, the expensing of business investment – a potent tool for boosting capital accumulation, productivity, and incomes – was set to be phased out over the 2023-26 period. This provision could be restored and made permanent by reducing spending on credits under the Inflation Reduction Act, or by rolling back the spending – such as $175 billion  to forgive student loans – associated with outgoing President Joe Biden’s executive orders.

If the new administration wanted to go further with tax policy, it could build on the 2016 House Republican blueprint for tax reform that shifted the business tax regime from an income tax to a cashflow tax. By permitting immediate expensing of investment, but not interest deductions for nonfinancial firms, this reform would stimulate investment and growth, remove tax incentives that favor debt over equity, and simplify the tax system.

That brings us to the third pillar of a successful growth strategy: efficient regulation. The issue is not “more” versus “less.” What really matters for growth is how changes in regulation can improve the prospects for growth through innovation, investment, and capital allocation, while focusing on trade-offs in risks. Those shaping the agenda should start with basic questions like: Why can’t we build better infrastructure faster? Why can’t capital markets and bank lending be nimbler? Not only do such questions identify a specific goal; they also require one to identify trade-offs.

Fortunately, financial regulation under the new administration is likely to improve capital allocation and the prospects for growth, given the leadership appointments already announced at the Securities and Exchange Commission and the Federal Reserve. But policymakers also will need to improve the climate for building infrastructure and enhancing the country’s electricity grids to support the data centers needed for generative artificial intelligence. This will require a sharper focus on cost-benefit analysis at the federal level, as well as better coordination with state and local authorities on permitting. Using federal financial support programs as carrots or sticks can be part of such a strategy.

Bessent’s emphasis on economic growth is spot on. By setting an ambitious 3% target for annual growth, he has provided the new administration a North Star to follow in devising its economic policies.

This commentary first appeared on Project Syndicate.

1/17/25 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss the pros/cons of tariffs and the impact of AI on the economy.

Welcome to the first podcast for the Spring 2025 semester from the Hubbard/O’Brien Economics author team. Check back for Blog updates & future podcasts which will happen every few weeks throughout the semester.

Join authors Glenn Hubbard & Tony O’Brien as they offer thoughts on tariffs in advance of the beginning of the new administration. They discuss the positive and negative impacts of tariffs -and some of the intended consequences. They also look at the AI landscape and how its reshaping the US economy. Is AI responsible for recent increased productivity – or maybe just the impact of other factors. It should be looked at closely as AI becomes more ingrained in our economy.

https://on.soundcloud.com/8ePL8SkHeSZGwEbm8

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

Yesterday at the Fed Something Happened That Was Unusual … or Was It?

Photo of Michael Barr from federalreserve.gov

President-elect Donald Trump has stated that he believes that presidents should have more say in monetary policy. There had been some speculation that once in office Trump would try to replace Federal Reserve Chair Jerome Powell, although Trump later indicated that he would not attempt to replace Powell until Powell’s term as chair ends in May 2026. Can the president remove the Fed Chair or another member of the Board of Governors? The relevant section of the Federal Reserve Act States that: “each member [of the Board of Governors] shall hold office for a term of fourteen years from the expiration of the term of his predecessor, unless sooner removed for cause by the President.”

“Removed for cause” has generally been interpreted by lawyers inside and outside of the Fed as not authorizing the president to remove a member of the Board of Governors because of a disagreement over monetary policy. The following flat statement appears on a page of the web site of the Federal Reserve Bank of St. Louis: “Federal Reserve officials cannot be fired simply because the president or a member of Congress disagrees with Federal Reserve decisions about interest rates.”

At his press conference following the November 7 meeting of the Federal Open Market Committee (FOMC), Powell was asked by a reporter: “do you believe the President has the power to fire or demote you, and has the Fed determined the legality of a President demoting at will any of the other Governors with leadership positions?” Powell replied: “Not permitted under the law.” Despite Powell’s definitive statement, because no president has attempted to remove a member of the Board of Governors, the federal courts have never been asked to decide what the “removed for cause” language in the Federal Reserve Act means.

The president is free to remove the members of most agencies of the federal government, so why shouldn’t he or she be able to remove the Fed Chair? When Congress passed the Federal Reserve Act in 1913, it intended the central bank to be able set policy independently of the president and Congress. The president and members of Congress may take a short-term view of policy, focusing on conditions at the time that they run for reelection. Expansionary monetary policies can temporarily boost employment and output in the short run, but cause inflation to increase in the long run.

As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), in a classic study, Alberto Alesina and Lawrence Summers compared the degree of central bank independence and the inflation rate for 16 high-income countries during the years from 1955 to 1988. As the following figure shows, countries with highly independent central banks, such as the United States, Switzerland, and Germany, had lower inflation rates than countries whose central banks had little independence, such as New Zealand, Italy, and Spain.

Yesterday, something unusual happened that might seem to undermine Fed independence. Michael Barr, a member of the Board of Governors and the Board’s Vice Chair for Supervision, said that on February 28 he will step down from his position as Vice Chair, but will remain on the Board. His term as Vice Chair was scheduled to end in July 2026. His term on the Board is scheduled to end in January 2032.

Barr has been an advocate for stricter regulation of banks, including higher capital requirements for large banks. These positions have come in for criticism from banks, from some policymakers, and from advisers to Trump. Barr stated that he was stepping down because: “The risk of a dispute over the position could be a distraction from our mission. In the current environment, I’ve determined that I would be more effective in serving the American people from my role as governor.” Trump will nominate someone to assume the position of vice chair, but because there are no openings on the Board of Governors he will have to choose from among the current members.

Does this episode indicate that Fed independence is eroding? Not necessarily because the Fed’s regulatory role is distinct from its monetary policy role. As financial journalist Neil Irwin points out, “top [Fed] bank supervision officials view their role as more explicitly carrying out the regulatory agenda of the president who appointed them—and that a new president is entitled, in reasonable time, to their own choices.” In the past, other members of the Board who have held positions similar to the one Barr holds have resigned following the election of a new president.

So, it’s unclear at this point whether Barr’s resignation as vice chair indicates that the incoming Trump Administration will be taking steps to influence the Fed’s monetary policy actions or how the Fed’s leadership will react if it does.