May 29, 2024

US inflation rate shows healthy signs of a growing economy

Amid the furore about whether the Federal Reserve will cut interest rates this year, Unhedged raises an important question — “Are higher rates inflationary?” (Unhedged,, April 18).

While higher rates are probably not inflationary in aggregate, there is a good case for an inflationary impact on some index components (eg housing), which may be having a bigger impact than usual at the moment. Higher rates also send the message that inflation is high, which may increase, or at least maintain, high consumer inflation expectations.

This is an important reminder that we should not assume too mechanical a link between interest rates and inflation. Central bankers should not believe that there is such a link, nor be swayed by a financial market narrative that assumes one. The underlying dilemma is that a fall in US consumer price inflation from the 3-4 per cent range to around 2 per cent has rarely if ever been achieved outside of recessions. The 1991 recession brought inflation down from the 3-5 per cent range typical in the mid and late 1980s to about 2.5-3 per cent. Inflation again fell after the 2001 recession, but trended up to a peak of 5 per cent just before the 2008 financial crisis, which predictably caused inflation to slump and remain below 2 per cent for much of the following decade. Progress from today’s inflation of 3.5 per cent will be slow as workers and businesses take time to adjust, but in a growing economy that is a healthy sign, not one we should be alarmed about. It would take a recession or a positive supply shock to cause a rapid fall in inflation from current levels.

Central bankers would be wise to have an easing bias, since they can easily react if growth and inflation were to tear away again. What is sometimes called “opportunistic disinflation” — that is, waiting for a positive supply shock to lower inflation rather than trying to engineer one through an economic slowdown — has much to recommend it in the current environment. If the economy went into recession, there would be a high risk of inflation falling below target, and it would be too late to react by easing policy. We could be back in the world of quantitative easing again, which nobody wants to return to.

Bill Smyth
Bagshot, Surrey, UK

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