As the Federal Reserve makes its way towards its goal of bringing inflation back to 2%, the last mile of the journey has proven to be both easy and hard. The central bank has held interest rates steady for eight months, relying on previous tightening efforts to do the heavy lifting. However, the slow easing of price pressures and the strong performance of the American economy have sparked discussions about potentially taking a more aggressive approach to combat inflation.
There was speculation leading up to a recent monetary-policy meeting about whether the Fed would revise its plan for three quarter-point rate cuts in 2024. Some measures of inflation have remained stubbornly high at around 3-4%, while the unemployment rate has stayed below 4%. Ultimately, the Fed decided to stick with its projection of three cuts in 2024, but adjusted its forecast for 2025 to three cuts from four.
Diverging measures of inflation, such as the consumer price index (CPI) and the personal consumption expenditures (PCE) price index, have played a role in shaping the Fed’s decisions. While the CPI has shown signs of inflation exceeding the 2% target, the PCE prices have remained in line with expectations. The Fed’s focus on the PCE, which factors in consumer behavior and is adjusted more frequently than the CPI, has given policymakers confidence in their approach.
The gap between the CPI and PCE measures of inflation can be attributed to various factors, including differences in adjustment frequencies and weightings of components like housing and airfares. The Fed’s ultimate goal is to guide the economy towards a neutral rate of interest, where monetary policy is neither too expansionary nor contractionary. Recent projections have shown a shift towards a slightly higher long-run rate, hinting at potential changes post-pandemic.
As the Fed continues on its path to combat inflation, the question of where it wants to end up remains unanswered. The last mile of the journey may be nearing its conclusion, but the central bank will still face challenges in determining the appropriate interest rate trajectory going forward. The Fed’s careful monitoring of inflation indicators and economic trends will play a crucial role in shaping its decisions in the coming months.
Source link
