By Raphael Bostic, President and Chief Executive Officer
October 3, 2023
The Federal Reserve has made significant progress in our campaign to lower inflation.
By the Federal Open Market Committee's (FOMC) preferred gauge—the Personal Consumption Expenditures price index—the inflation rate has fallen to around 3 percent from 7 percent in the summer of 2022.
However, our objective is 2 percent, so we still have work to do.
One more percentage point may not sound like much, but the path from here to the target rate probably will not be a straight, unbroken line. It hasn't been that way yet. The trend of declining inflation over the past 12 months has included occasional blips upward. (See chart 1.)
So, as we continue the campaign to reach 2 percent inflation, the key for the FOMC is to be patient and not overreact to individual data points lest we miss true signals about the economy's evolution amid considerable noise and uncertainty.
By true signals, in the case of inflation I mean the indicators that give us the best read on the trajectory of underlying price inflation. That's different from a one-month number skewed by swings in the prices of a few goods or services.
Our job is to tease out those true inflation signals because they guide us in calibrating monetary policy. To that end, my staff and I follow numerous inflation gauges: the widely known PCE and Consumer Price Index (CPI) measures, of course, but also a dashboard of other instruments the Atlanta Fed designed to discern the true signal.
Taken together, those alternative measures continue to describe slowing underlying price growth. I'll quickly mention one measurement our economists and I think is telling. Among hundreds of individual prices, we aim to determine how many important ones are rising quickly each month. We use 5 percent as a reasonable marker.
In the past four months, on average, 36 percent of prices in the CPI, weighted by expenditures, have risen 5 percent or more. (Weighted by expenditures means the things consumers spend the most money on count the most.)
Granted, a little over a third is higher than the typical 15 to 20 percent of prices that rose quickly each month before the pandemic. But more germane to our current inflation battle, 36 percent is well below the readings of over 60 percent that we saw in 16 of 17 months through February 2023. (See chart 2.)
We are making progress. Furthermore, the Atlanta Fed Business Inflation Expectations survey and conversations with price setters tell me the downward momentum of inflation is likely to continue. Our surveys and grassroots information channels have a strong track record, so I feel confident in their predictive ability.
Labor markets continue to cool
Starting in March 2022, the FOMC has increased the federal funds rate from zero to a range of 5 ¼ to 5 ½ percent as of September. The optimal outcome of the Fed's historic and aggressive monetary policy tightening cycle would be 2 percent inflation in a reasonable time frame without widespread economic pain, the so-called "soft landing" or, as my colleague Austan Goolsbee calls it, the "golden path."
Achieving this outcome will require aggregate demand and supply to come more into balance. We have seen signs of that balance coming closer in many areas.
Consider labor markets. Monthly employment growth in June, July, and August averaged about 150,000. That's a healthy number by historical standards, but considerably lower than last year's monthly average gains of 400,000 jobs.
A deeper look at these numbers makes the breadth of the slowdown even more apparent. Breaking out employment growth by sector, the robust hiring has in recent months been concentrated in a single industry: health care and social assistance. This industry accounts for about 14 percent of total payroll employment. But its share of employment growth has increased in the past year from 20 percent to 60 percent. Thus, over the past three months, employment in the rest of the economy—accounting for 86 percent of jobs—has grown on average by only about 60,000 jobs a month. That compares with 343,000 net new jobs in August of 2022.
Meanwhile, reports from employers suggest the slowdown in the labor market will continue. Executives tell me it is easier to fill openings, turnover is lower, and demand for workers figures to slacken further. Some firms—not a majority—are reducing employment, mostly through means other than layoffs.
Wage growth has slowed a bit, and our surveys and direct conversations with executives indicate that trend will likely persist into 2024.
Risks appear to be more balanced
Despite the good news to date concerning inflation, achieving a soft landing is not assured. And, unlike in the last few years, the risks to my outlook are more balanced.
Many factors could derail inflation's continued progression to our 2 percent target. One wildcard is the price of energy, not only because of its direct impact on the price of consumer staples like gasoline, but also because petroleum is a key ingredient in myriad goods and services and therefore affects those prices too. The price of West Texas intermediate crude oil in early October was around $90 per barrel, rising from under $70 in June. This bears watching over the coming months.
A second risk is the ever-present specter of geopolitical shocks. The war in Ukraine, for example, triggered higher broad-based inflation globally, especially in Europe, and it took many months to unwind.
While these factors represent upside risks to inflation, others could conversely accelerate inflation's decline to our target. Some pandemic-era supports are ending, such as childcare subsidies, expanded child tax credits and student loan forbearance. Their expiration unfortunately will leave some Americans with less money to spend, but that could translate into a steeper reduction in aggregate demand.
Similarly, many American families are spending down the extra savings they've enjoyed. People accrued heftier bank balances in part due to a healthy labor market and pandemic-era supports at a time when lockdowns limited spending options. Today, bankers tell our staff and me that while the balances of many customers remain higher than they averaged before the pandemic, a growing share of depositors' balances are at or slightly below prepandemic levels. For these latter customers, spending could decline significantly, which would put additional downward pressure on inflation.
Lastly, a factor that is a bit trickier to interpret is gross domestic product, or GDP, the broadest measure of economic activity. One line of thinking is that the economy cannot return to balance as long as GDP is running higher than its longer-term trend because anything higher than trend should put upward pressure on prices. On the other hand, elevated GDP will not be inflationary—and could even be associated with disinflation—if worker productivity rises. So, one needs to look to other signals in addition to GDP to conclude that faster economic growth is hurting or helping in the fight against inflation.
The job is not done
As for the stance of monetary policy, I believe it is sufficiently restrictive now. And because I expect the path to 2 percent inflation to be bumpy, I believe our policy rate must remain at this level well into 2024.
Uncertainty and risks mean that the FOMC must stay vigilant to ensure that inflation does not reverse its trajectory. Though momentum is in the right direction, it's too early to claim victory in our fight. Higher prices have inflicted hardship on many American households. That must not happen again.
At the same time, we have made great progress while avoiding the widespread unemployment and slower economic growth that many predicted would need to occur for inflation to have fallen to today's level. That has put a soft landing within reach, and I will be working hard to try to achieve it.
But let me be clear: to realize the durable economic expansion and labor market growth that will benefit all Americans, we must subdue elevated inflation. That is job one.
Wringing inflation out of the economy is hard work.
But this is the work these times require. And we will do it because the FOMC is firmly committed to restoring price stability.