A Strong Economy Doesn’t Necessarily Make the Fed’s Job Harder

The US economy expanded at a strong 3% last year, though growth slowed to a 1.6% annual rate in the first quarter with a drag from imports. Even so, consumer spending and business fixed investment — which is less volatile, and usually gives a better sense of where the economy is headed — rose at a brisk 3%.

Contrary to what commentators such as former Treasury Secretary Larry Summers might say, this strong economy does not complicate the US Federal Reserve’s fight against inflation, nor is it a reason for the bank to delay rate cuts. The past year shows that it is possible to have a rapid decrease in inflation along with low unemployment and strong growth. Notwithstanding 2024’s bumpy start on inflation, there is reason to believe that the tradeoff between demand and inflation is weaker now than in the past.

What’s unusual in this cycle is the pandemic. It drove disruptions in global supply chains, vehicle production, labor force participation, housing construction, spending on goods (which increased during the pandemic) and demand for services (which rose after it ended). All of this has contributed significantly to inflation.

Now the rebalancing is nearly complete: PCE prices, excluding food and energy, are less than a percentage point from the Fed’s target and about half their peak. At the same time, while they are waning, the economic echoes of the pandemic are ongoing.

The motor vehicle and related sectors are one example of the complex linkages. Supply chains — as measured by the New York Fed’s index — began to improve in late 2021. Soon after that, new and used vehicle inflation began to ease. Inflation in motor vehicle parts, however, continued to rise, not easing until mid-2022. Then inflation moved into services such as repair and maintenance and insurance.