The Last Mile of Inflation Has a Bad Reputation

In the rapidly evolving outlook for interest rates, some things are still sacrosanct. The pace of price increases has slowed significantly, and the argument is now how much — rather than when — borrowing costs will be lowered this year. Traders have latched on to the idea that relief will come by March, and some economists even flag a period of below-target inflation. The folks actually making the decisions sound unconvinced, and have fallen back on two lines of defense that can use a rigorous stress test.

Despite bets they will capitulate within months, officials cling to a couple of well-worn phrases: the last mile of the inflation fight is the hardest, and the very worst thing would be to declare victory. The assertions are related. They translate to “Don't push us, the spike of 2021 and 2022 remains too raw.” Christine Lagarde, president of the European Central Bank, chided traders last week and warned that speculation about cuts is unhelpful to policy deliberations. It's almost as if raising the issue is a punishable offense.

Salons in Davos last week were replete with denials that a win is at hand. Nor has the refutation been limited to chattering on the slopes. “Mission is not accomplished yet, but it's on track,” Ravi Menon, who led the Monetary Authority of Singapore, said in one of his last interviews before retiring from the civil service in December. The International Monetary Fund recently urged officials to stand firm in “the very last mile” of the inflation fight. What did this last mile do to have warranted, in equal measure, such vilification and reverence?

A new paper from the Federal Reserve investigated the last-mile theory and found it wanting. David Rapach, an economist at the Atlanta Fed, wrote that the analogy is grounded in a long race where an athlete tires as the end is in sight and needs extra exertions to get there. The finish line is the 2% inflation target. The Fed's preferred measure rose 2.6% in November from a year earlier, within striking distance.

The concern is that the last stretch will require something more. Officials will need to extract an additional cost from the economy in terms of jobs and growth. However, it's not obvious to Rapach that the sporting analogy works. “For the last 1 to 2 percentage points of disinflation to be fundamentally more difficult than the preceding decline in inflation, there must be some sort of structural mechanism that makes the last mile different from the rest,” he argued. “Such mechanisms are not readily apparent in conventional macroeconomic models. Thus, the contention that the last mile of disinflation is more arduous deserves serious scrutiny.”

Rapach evaluated the notion that inflation in services, as opposed to goods, is particularly tough to repress. According to this popular school of thought, getting the cost of manufactured items down is relatively easy. Services, in contrast, are recalcitrant enough to warrant some additional tightening. But “sticky” doesn't mean harder, he wrote. It requires more patience, not necessarily some extra exertion.