Monetary Policy – HubbardOBrienEconomics.com Blog

Inflation Cools Slightly in Latest CPI Report

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The FOMC Follows the Expected Course in Its Latest Meeting

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

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

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

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

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

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

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

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

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

Latest Wage Data Another Indication of the Persistence of Inflation

Photo courtesy of Lena Buonanno.

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

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

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

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

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

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

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

Will the Fed Not Cut Rates at All this Year?

Federal Reserve Vice Chair Philip Jefferson (photo from the Federal Reserve)

Federal Reserve Chair Jerome Powell (photo from the Federal Reserve)

At the beginning of 2024, investors were expecting that during the year the Fed’s policy-making Federal Open Market Committee (FOMC) would cut its target range for the federal funds rate six or seven times. At its meeting on March 19-20 the economic projections of the members of the FOMC indicated that they were expecting to cut the target range three times from its current 5.25 percent to 5.50 percent. But, as we noted in this recent post and in this podcast, macroeconomic data during the first three months of this year indicated that the U.S. economy was growing more rapidly than the Fed had expected and the reductions in inflation that occurred during the second half of 2023 had not persisted into the beginning of 2024.

The unexpected strength of the economy and the persistence of inflation above the Fed’s 2 percent target have raised the issue of whether the FOMC will cut its target range for the federal funds rate at all this year. Earlier this month, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis raised the possibility that the FOMC would not cut its target range this year.

Today (April 16) both Fed Vice Chair Philip Jefferson and Fed Chair Jerome Powell addressed the issue of monetary policy. They gave what appeared to be somewhat different signals about the likely path of the federal funds target during the remainder of this year—bearing in mind that Fed officials never commit to any specific policy when making a speech. Adressing the International Research Forum on Monetary Policy, Vice Chair Jefferson stated that:

“My baseline outlook continues to be that inflation will decline further, with the policy rate held steady at its current level, and that the labor market will remain strong, with labor demand and supply continuing to rebalance. Of course, the outlook is still quite uncertain, and if incoming data suggest that inflation is more persistent than I currently expect it to be, it will be appropriate to hold in place the current restrictive stance of policy for longer.”

One interpretation of his point here is that he is still expecting that the FOMC will cut its target for the federal funds rate sometime this year unless inflation remains persistently higher than the Fed’s target—which he doesn’t expect.

Chair Powell, speaking at a panel discussion at the Wilson Center in Washington, D.C., seemed to indicate that he believed it was less likely that the FOMC would reduce its federal funds rate target in the near future. The Wall Street Journal summarized his remarks this way:

“Federal Reserve Chair Jerome Powell said firm inflation during the first quarter had introduced new uncertainty over whether the central bank would be able to lower interest rates this year without signs of an economic slowdown. His remarks indicated a clear shift in the Fed’s outlook following a third consecutive month of stronger-than-anticipated inflation readings ….”

An article on bloomberg.com had a similar interpretation of Powell’s remarks: “Federal Reserve Chair Jerome Powell signaled policymakers will wait longer than previously anticipated to cut interest rates following a series of surprisingly high inflation readings.”

Politics may also play a role in the FOMC’s decisions. As we discuss in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4), the Federal Reserve Act, which Congress passed in 1913 and has amended several times since, puts the Federal Reserve in an unusal position in the federal government. Although the members of the Board of Governors are appointed by the president and confirmed by the Senate, the Fed was intended to act independently of Congress and the president. Over the years, Fed Chairs have protected that independence by, for the most part, avoiding taking actions beyond the narrow responsibilites Congress has given to the Fed by Congress and by avoiding actions that could be interpreted as political.

This year is, of course, a presidential election year. The following table from the Fed’s web site lists the FOMC meetings this year. The presidential election will occur on November 5. There are four scheduled FOMC meetings before then. Given that inflation has been running well above the Fed’s target during the first three months of the year, it would likely take at least two months of lower inflation data—or a weakening of the economy as indicated by a rising unemployment rate—before the FOMC would consider lowering its federal funds rate target. If so, the meeting on July 30-31 might be the first meeting at which a rate reduction would occur. If the FOMC doesn’t act at its July meeting, it might be reluctant to cut its target at the September 17-18 meeting because acting close to the election might be interpreted as an attempt to aid President Joe Biden’s reelection.

Although we don’t know whether avoiding the appearance of intervening in politics is an important consideration for the members of the FOMC, some discussion in the business press raises the possibility. For instance, a recent article in the Wall Street Journal noted that:

“The longer that officials wait, the less likely there will be cuts this year, some analysts said. That is because officials will likely resist starting to lower rates in the midst of this year’s presidential election campaign to avoid political entanglements.”

These are clearly not the easiest times to be a Fed policymaker!

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.

NEW! 4/5/24 Podcast – Authors Glenn Hubbard & Tony O’Brien react to the newest Friday Jobs Report for March & discuss next steps for the Economy.

Join authors Glenn Hubbard & Tony O’Brien as they react to the jobs report of over 300K jobs created which was way over expectations of about 200K. They consider the impact of this report as the Fed considers the next steps for the economy. Are we on a glide path for a soft landing at 2% inflation or will the Fed reconsider its long-standing target by adopting a higher 3% target? Glenn and Tony offer interesting viewpoints on where this is headed.

Upward Revision of 2023 Fourth Quarter Real GDP Growth May Add to Fed’s Hesitancy to Raise Fed Funds Target

(Photo courtesy of Lena Buonanno)

The Bureau of Economic Analysis (BEA) has issued its third estimate of real GDP for the fourth quarter of 2023. The BEA now estimates that real GDP increased in the fourth quarter of 2023 at an annual rate of 3.4 percent, an increase from the BEA’s second estimate of 3.2 percent. The BEA noted that: “The update primarily reflected upward revisions to consumer spending and nonresidential fixed investment that were partly offset by a downward revision to private inventory investment.”

As the blue line in the following figure shows, despite the upward revision, fourth quarter growth in real GDP decline significantly from the very high growth rate of 4.9 percent in the third quarter. In addition, two widely followed “nowcast” estimates of real GDP growth in the first quarter of 2024 show a futher slowdown. The nowcast from the Federal Reserve Bank of Atlanta estimates that real GDP will have grown at an annualized rate of 2.1 percent in the first quarter and the nowcast from the Federal Reserve Bank of New York estimates a growth rate of 1.9 percent. (The Atlanta Fed describes its nowcast as “a running estimate of real GDP growth based on available economic data for the current measured quarter.” The New York Fed explains: “Our model reads the flow of information from a wide range of macroeconomic data as they become available, evaluating their implications for current economic conditions; the result is a ‘nowcast’ of GDP growth ….”)

Data on growth in real gross domestic income (GDI), on the other hand, show an upward trend, as indicated by the red line in the figure. As we discuss in Macroeconomics, Chapter 8, Section 8.4 (Economics, Chapter 18, Section 18.4), gross domestic product measures the economy’s output from the production side, while gross domestic income does so from the income side. The two measures are designed to be equal, but they can differ because each measure uses different data series and the errors in data on production can differ from the errors in data on income. Economists differ on whether data on growth in real GDP or data on growth in real GDI do a better job of forecasting future changes in the economy. Accordingly, economists and policymakers will differ on how much weight to put on the fact that while the growth in real GDI had been well below growth in real GDP from the fourth quarter of 2022 to the fourth quarter of 2023, during the fourth quarter of 2023, growth in real GDI was 1.5 percentage points higher than growth in real GDP.

On balance, it seems likely that these data will reinforce the views of those members of the Fed’s policy-making Federal Open Market Committee (FOMC) who were cautious about reducing the target for the federal funds rate until the macroeconomic data indicate more clearly that the economy is slowing sufficiently to ensure that inflation is returning to the Fed’s 2 percent target. In a speech on March 27 (before the latest GDP revisions became available), Fed Governor Christopher Waller reviewed the most recent macro data and concluded that:

“Adding this new data to what we saw earlier in the year reinforces my view that there is no rush to cut the [federal funds] rate. Indeed, it tells me that it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2 percent.”

Most other members of the FOMC appear to share Waller’s view.

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.

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.