The Fed Shouldn’t Settle for Above-Target Inflation
Financial-market analysts agree that the Federal Reserve will raise interest rates another notch this week. But they’re split on where monetary policy might go after that. The Fed needs to resolve this disagreement — by making clear that it’s committed to getting inflation all the way back down to the 2% target.
Fed officials are expected to approve a quarter-point rise, and investors would be shocked if it didn’t happen. At the same time, markets have moved from expecting further tightening beyond this week’s decision to thinking this rise might be the last. Why? Some are betting inflation is already as good as beaten. Others think the Fed won’t risk further tightening, and possibly causing a recession, if inflation levels off at say 3%.
Recent news on inflation has indeed been encouraging. Consumer prices rose 3% in the year to June, down from an increase of 4% in the year to May and almost 5% in the year to April. This was a faster decline than expected. But measures of underlying inflation haven’t fallen as much. The consumer price index excluding food and energy — the so-called core CPI — was still 4.8% higher in June than a year ago. Inflationary pressure in the labor market seems to be subsiding, but again only slowly. Unemployment is very low, vacancies are elevated, and average hourly earnings are rising by more than 4% a year. Assuming productivity continues to grow at between 1% and 1.5% a year, such rapid wage increases can’t be squared with 2% inflation.