Inflation has come down from its historic highs, though not far enough to stop plaguing the economy just yet.
That’s the takeaway from data released yesterday. First, the good news: Prices rose at their slowest pace in nearly two years, having climbed 5 percent in the 12 months that ended in March. The increase is still higher than the 2 percent annual rate that policymakers seek to keep the economy humming — but is down from a peak of 9 percent last summer.
The bad news is that other measures — particularly indicators that exclude food and energy prices, which are known as core inflation — tell a more mixed story. In the chart below, you can see that core inflation is more stable than overall inflation and, for that reason, is less prone to misinterpretation.
“We’re past peak inflation,” said my colleague Jeanna Smialek, who covers the Federal Reserve, America’s central bank. “But inflation is still pretty stubborn.”
The mixed news suggests that the Fed’s recent moves have worked to tame inflation, but that more action is needed to get price increases down to sustainable levels. Today’s newsletter will break down the data and what the Fed might do next.
Mixed picture
There is an underlying story behind the numbers, starting a few years ago. Flush with money from Covid relief legislation and stuck at home during the pandemic, Americans bought more things they could use in their homes. So prices for goods — physical stuff like furniture and appliances — increased sharply over 2021.
As the economy has recovered from the Covid shock and people have started to go out again, consumer demand is shifting to services — things you pay people to do, like make food for you at a restaurant or fly you across the country. Prices are rising accordingly, particularly across airlines, transportation and restaurants, as you can see in this chart:
That trend is what policymakers are looking at now. It suggests consumer demand is still too high — first chasing limited goods and now chasing limited services, leading to increases in prices.
There are some good signs for the prospect that inflation will fall further. The flood of cash that people got from the government during the pandemic is drying up, reducing consumer demand. The supply chain has largely untangled itself from the snarls of the earlier Covid days. The shock to oil and gas prices from Russia’s invasion of Ukraine has eased. The Federal Reserve, in an effort to further restrain demand, has increased interest rates to make borrowing money more expensive.
But there are also some potentially bad signs. American consumers are still spending a lot, taking advantage of higher wages and savings accumulated during the pandemic. The cartel of oil-producing countries, OPEC, is cutting its production to try to raise prices. The longer inflation persists, the more likely it is to become ingrained in the economy — making it more difficult to bring down further. “It’s not that inflation is going to take back off and spike again, but that we might not be able to fully stamp out what remains of it,” Jeanna said.
What’s next
Going forward, policymakers will probably try to take a balanced approach to match the mixed story. The Federal Reserve is likely to take more measured steps than it did last year. The central bank regularly increased rates by half a point or more for much of 2022, but it adopted a smaller quarter-point increase last month and is widely expected to repeat that step at its next meeting in May.
There is a risk that the Fed does too little and inflation persists, as happened in 2021. But there is also a risk that the Fed goes too far and does unnecessary damage to the economy, as this newsletter has explained before. A strong economy can lead to faster price increases. But a weak economy can put a lot of people out of work. Policymakers are trying to find a sweet spot between those two extremes.
The latest inflation data suggests that the country is getting there — that an end to rapidly rising prices is perhaps becoming visible now. But the data is not clear enough to rule out a mirage.
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