Inflation ‘bursts’ may exceed Fed’s 2% target due to public debt: Brookings

Dive Brief:

Inflation in coming years may sometimes surge above the 2% target set by the Federal Reserve and other central banks as falling world trade and rising government debt drive up price pressures, economists said in a paper published by the Brookings Institution.
Trade as a share of global gross domestic product shrunk to 57% in 2021 from 61% in 2008, and public debt is forecast this decade to rise in proportion to GDP, Harvard University Economics Professor Ken Rogoff and other academics said in the paper, citing the World Bank and International Monetary Fund.
“Maintaining low and stable inflation may be challenging in the coming decade” for central bankers in the U.S., Europe and other regions, they said. “If political economy pressures do result in higher than average inflation, this will likely come in the form of occasional bursts of inflation, such as after the pandemic, rather than an inflation rate that continuously exceeds the target.”

Dive Insight:

Fed officials in recent months have made slower progress in curbing inflation than in 2023. Some measures of inflation edged up during January and February after falling steadily for much of last year, reinforcing caution among policymakers who want to see more easing in price pressures before cutting the main interest rate from a 23-year high.

The central bank’s preferred inflation gauge — the core personal consumption expenditures price index — rose 0.3% in February after a 0.5% gain in January, the Commerce Department said Friday. On an annual basis, the inflation measure increased 2.8%.

At the same time, the core consumer price index, which also excludes volatile food and energy prices, increased 0.4% in February from January and 3.2% on an annual basis, well above the Fed’s target.

Services prices, which shift more slowly than other inflation components, gained 0.5% during February and 5.2% over 12 months, with a 0.4% increase in shelter costs the biggest driver of services inflation, according to the Labor Department.

“Adding this new data to what we saw earlier in the year reinforces my view that there is no rush to cut the policy rate,” Fed Governor Christopher Waller said Wednesday, referring to forecasts for the 0.3% monthly gain in core PCE reported Friday.

“Indeed, it tells me that it is prudent to hold this rate at its current restrictive stance perhaps for longer than previously thought to help keep inflation on a sustainable trajectory toward 2%,” he said in a speech.

Fed Chair Jerome Powell on Friday referred to the core PCE data released earlier in the day in comments similar to those by Waller. The new data are “pretty much in line with our expectations,” he said at a San Francisco Fed event.

“The fact that the U.S. economy is growing at such a solid pace, the fact that the labor market is still very, very strong, gives us the chance to just be a little more confident about inflation coming down before we take the important step of cutting rates,” he said.

Fed policymakers on March 20 held the main interest rate at a 23-year high for the fifth consecutive policy meeting and forecast reductions in the federal funds rate this year totaling 0.75 percentage point.

The central bank will likely trim the federal funds rate by the end of 2024 to 4.6% from the current range between 5.25% and 5.5%, according to a median projection by Fed officials. Core PCE will probably fall by the end of this year to a 2.6% annual rate, according to Fed officials’ median projection.

Policymakers face several inflationary forces beyond their control, including rising government spending on defense, aging populations, subsidies for industries such as semiconductors and programs to achieve net-zero carbon emission targets, the economists said in their paper.

Also, after raising benchmark interest rates at the fastest pace in years, policymakers have more leeway to trim rates to stimulate their economies, boosting inflation, they said.

“Temporary periods of elevated inflation — perhaps even as high as post-pandemic — could become more common relative to the past,” the economists said.

Curbing inflation in coming years may hinge on legislative changes that bolster central bank autonomy and reduce government debt, they said.

“For inflation to remain low and stable in the future, political economy factors, such as strengthened central bank independence or more credible public debt policy, would need to offset the global economic pressures now pushing average long-run inflation upwards,” the economists said.