Year-over-year inflation failed to meet economists’ expectations in January after not dropping below 3%, leading experts to speculate if achieving the Federal Reserve’s inflation goal is achievable under current conditions.
The consumer price index (CPI) was reported to be 3.1% year-over-year for January on Tuesday, declining from 3.4% in December, but well above expectations of 2.9% and the Fed’s goal rate of 2%. Opinions are mixed on whether inflation is truly trending toward the Fed’s target, with some economists seeing the rate as highly fluctuating and unpredictable while others point to factors keeping it closer to 3%, according to experts who spoke to the Daily Caller News Foundation.
“The Fed bases some of its estimates off the concept of a natural rate of interest,” Peter Earle, economist at the American Institute for Economic Research, told the DCNF. “The natural rate of interest is a theoretical concept that indicates the interest rate at which the supply of savings equals the demand for investment in a fully functioning, stable economy with stable inflation and full employment. It’s an equilibrium concept. But, of course, that rate is not directly viewable, so its value is estimated. Not only that, but whatever that rate is, it’s not static — it’s changing at every moment. Equilibrium is a concept in economic models, rarely if ever seen in the real world.”
The natural rate aims to gauge at what level the Fed should put the federal funds rate to counteract inflationary pressures by tightening credit conditions and, in turn, dampening the economy. The federal funds rate is currently in a range of 5.25% and 5.50%, the highest rate in 23 years, in an effort to bring down inflation that peaked at 9.1% in June 2022.
“There likely is a natural rate, but figuring out what that natural rate is … that’s not so easy,” Norbert Michel, vice president and director of the Cato Institute’s Center for Monetary and Financial Alternatives, told the DCNF. “The rate of inflation has generally been on a downward trend, so we can say it is ‘trending toward 2%,’ though how fast it might get there is not so easy to predict.”
CPI was commonly below or around 2% from 2012 up to 2021, after which inflation began rapidly rising starting in March and April of 2021, according to the Federal Reserve Bank of St. Louis (FRED). Inflation decelerated quickly from its peak in June 2022, reaching around 3.1% year-over-year in June 2023 and remaining stubbornly above 3% since.
Ladies, this Valentine’s Day, find yourself a man who sticks around as long as “transitory” inflation does: pic.twitter.com/cdGQIeg4DQ
— E.J. Antoni, Ph.D. (@RealEJAntoni) February 14, 2024
“Presently, it looks like disinflation is continuing, but with a lot of fits and starts and the occasional reversal of direction,” Earle told the DCNF. “If you look at the 1980s, you see inflation fall from incredible highs to a low between 2% and 3%, and then back above 4% with only an occasional dip below 3% for the rest of the decade, despite the Fed hikes in the mid- and then late-1980s. Getting the annual rate of inflation down to the 2% area, which is the Fed’s current target, is going to be a slow, bumpy, and uncertain process.”
The U.S. experienced a more extreme bout of inflation starting in the 1970s, peaking at over 14% year-over-year in March 1980, according to FRED. The federal funds rate was then set to over 17% in April 1980 and then to over 19% in June 1981, leading to a rapid decline in inflation and ultimately triggering a recession.
Some economists see the current rate of federal spending and government policies related to the money supply as continuing to fuel inflation, increasing the neutral rate, and making dampening inflation unlikely without more rate hikes. The U.S. national debt hit $34 trillion for the first time just before the end of 2023, after adding more than $800 billion in new debt in just the fourth quarter.
“Those telling us that inflation has been trending toward 2% clearly didn’t look at any of the available data, which shows we’ve been steadily trending toward 3%,” E.J. Antoni, a research fellow at the Heritage Foundation’s Grover M. Hermann Center for the Federal Budget, told the DCNF. “We’ve arrived there, and there’s no indication we’ll be going significantly lower anytime soon. We have a Treasury borrowing almost $2 trillion a year and rising while the Federal Reserve is allowing the money supply, bank reserves, and credit to all expand.”
Following the disappointing CPI report, more investors are betting on a “no landing” scenario where inflation would remain elevated but strong economic growth would continue, threatening factors like real wages that struggle to keep up with inflation. Investors and the Fed have remained hopeful for a soft-landing scenario, where inflation is brought down to the target range without triggering a recession.
“I like to remind folks that for several years prior to the Great Recession, and many years after the Great Recession, the US was under the 2% target,” Michel told the DCNF. “We should probably be asking ourselves whether the Fed can precisely hit a target.”
The Fed did not immediately respond to a request to comment from the DCNF.
Will Kessler on February 14, 2024