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Inflation isn’t dead yet

The Federal Reserve’s campaign of interest rate hikes has been surprisingly successful in cooling inflation without sparking a job-killing recession. But the job isn’t finished, and therein lies the danger.

Food prices are still climbing fast, but overall inflation has slowed significantly.Joe Raedle/Getty

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Many of the economic disruptions wrought by COVID-19, federal stimulus, and Russia’s invasion of Ukraine are behind us: supply shocks, the mad scramble for suburban housing, overheated consumer spending, $5-a-gallon gasoline.

And, as a result, inflation is a lot lower than it was a year ago.

On Thursday, a reading of wholesale prices in June showed a decline for the second straight month. Inflation as measured by the producer price index averaged 2.7 percent in the first half of the year, down from a dizzying 13.6 percent in all of 2022.

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The June consumer price index report, which was released on Wednesday, featured the smallest year-over-year increase since March 2021. Inflation at the consumer level is running at an annual rate of 3 percent, just a third of its peak of 9.1 percent one year ago.

There’s no denying that the Federal Reserve’s 17-month campaign of interest rate hikes has been surprisingly successful in cooling inflation without sparking a job-killing recession. But the job isn’t finished, and therein lies the danger.

Central bank officials say they are determined to get core inflation, which excludes volatile food and energy prices, to 2 percent. It’s a target the central bank formally adopted in 2012 as the optimal longer-term average to meet its twin mandate of promoting stable prices and maximum employment.

Core inflation, as measured by the consumer price index, was 4.8 percent last month.

To drag core inflation even lower, Fed officials are widely expected to boost rates when they meet July 25-26. If price gains don’t soften in response, policymakers could hike again before the end of the year.

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Credit tightening works with a lag, so the worry is that the Fed throttles the economy for longer than needed, causing a recession.

It’s a tricky situation.

While the job market remains robust, hiring has been slowing for months. Overshooting is a real risk.

Meanwhile, some economists think that the Fed’s target is too low.

“We are in a different world,” said Brian Bethune, an economist at Boston College. “The 2 percent inflation target needs to be comprehensively reexamined. It’s an anachronism.”

Bethune argued that several fundamental changes to the economy will put upward pressure on prices in ways that shouldn’t necessarily be deemed inflationary in the conventional view.

Federal Reserve officials say they are determined to get core inflation, which excludes volatile food and energy prices, to 2 percent. Al Drago/Bloomberg

First, he said there’s an ongoing structural shift in labor market sectors such as hospitals, supermarkets, and restaurants where workers have gained the leverage to demand higher pay for jobs that are now perceived to be significantly more risky than before the pandemic. Unless there is an off-setting adjustment to wages for other occupations — which will take years, if it happens at all — overall compensation will increase at a faster pace than in the past.

Second, the effort to achieve net-zero carbon emissions will require huge outlays to produce batteries, transform the electric grid, retool car and truck manufacturing, and make the myriad of other changes needed to phase out oil and gas. The costs of those investments will invariably be borne by consumers and businesses as a “green premium” on goods and services.

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Third, US efforts to promote domestic manufacturing and import less from China and other countries will push prices higher.

Bethune also noted that high interest rates are diverting risk capital from investments that support productivity-boosting innovation. Investors have pulled back from venture capital deals and initial public offerings in tech and biotech, for example.

“It’s jeopardizing the pace of productivity,” he said. “Low productivity and low innovation is the worst possible combination. It’s stagflation.”

Michael Klein, a Fletcher School economist and founder of its EconoFact website, agrees that the 2 percent inflation bogey “is pretty arbitrary and is pretty low.”

But he believes that the Fed won’t adjust its target any time soon out of concern it would damage its credibility.

“There’s a difference between allowing 3 percent inflation if it’s been below 2 for a long time and when it’s coming down from 9 percent,” Klein said.

The news on inflation is good, no doubt about it. Is a soft landing — no recession — a sure thing?

Hardly.

“The best you can say,” Klein concluded, “is that we are on the right path.”


Larry Edelman can be reached at larry.edelman@globe.com. Follow him @GlobeNewsEd.