May 02, 2018
This is an important point to remember in coverage of the Federal Reserve Board’s plans on interest rates. Former Fed Chair Janet Yellen repeatedly reminded the public that the 2.0 percent target is intended to be an average.
The inflation rate, as measured by the consumer price expenditure deflator, has been under 2.0 percent for most of the last six years. This means the Fed should be prepared to allow the rate to rise modestly above 2.0 percent given its target. We will have a recession at some point in the future, which will lower the inflation rate. This means the Fed should be looking to have the inflation rise to perhaps 2.5 percent, or even slightly higher if 2.0 percent is the actual target.
It is also worth noting that inflation has not been following the normal pattern in past recoveries. The inflation we are seeing is hugely concentrated in housing. Pulling out rent, the core inflation rate is rising at roughly a 1.0 percent annual rate. In the past, rental inflation has not differed much from the rate of inflation in other goods and services.
Rents are driven by a shortage of housing, not wage-cost pressures. Also, higher interest rates are likely discouraging construction, making the housing shortage worse, so it’s not clear that higher interest rates are a good mechanism to combat the inflation we are now seeing.
CPI Minus Food, Energy, and Shelter: Percent Change Last 12 Months
Source: Bureau of Labor Statistics.
Comments