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Federal Reserve on cusp of what some thought impossible: Defeating inflation without steep recession

by Michael Nguyen
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Federal Reserve Inflation Strategy

The Federal Reserve appears to have achieved a remarkable feat: taming inflation without triggering a severe recession, a prospect that had worried many economists. This recent achievement comes after experiencing the most significant inflationary pressures since 1981.

Inflation, which had surged to 9.1% in June of the previous year, has been steadily declining. Economists at UBS estimate that the upcoming report on the Fed’s preferred inflation gauge for November will likely reveal that annual inflation dipped just below the Fed’s 2% target over the past six months.

Several factors have contributed to this decline. The prices of goods, including used cars, furniture, and appliances, have dropped for six consecutive months. Improved global supply chains have helped keep goods prices stable compared to the previous year. Housing and rental costs, which had been a significant driver of inflation, are now growing at a slower pace. Wage growth has also cooled down, although it remains above the inflation rate. This milder wage growth has reduced the pressure on businesses like restaurants and hotels to raise prices to cover labor costs.

Federal Reserve Chair Jerome Powell expressed optimism about the progress during a recent news conference. He mentioned, “I think it’s really good to see the progress that we’re making.” However, he emphasized that no one is declaring victory, and the central bank wants to see further evidence of sustained inflation decline before feeling confident about achieving its 2% target.

While caution remains, many economists are now inclined to believe that inflation is almost back under control after affecting millions of American households for more than two years. Tim Duy, chief economist at SGH Macroeconomics, remarked, “It appears that inflation has returned to 2%. The Fed looks like it has won that battle.”

Moreover, inflation is moderating in other parts of the world as well. The Bank of England and the European Central Bank have kept their benchmark interest rates unchanged, reflecting a global trend of cooling inflation.

This shift in the inflation landscape has prompted discussions within the Federal Reserve about potential rate cuts. The central bank, which had embarked on a rate-hiking campaign earlier, is now projecting three rate cuts for the next year, marking a significant departure from its previous stance.

The recent developments have had a positive impact on financial markets, with stock market indexes surging. There is a growing anticipation that the first rate cut could occur as early as March, with expectations of a total of six cuts in 2024.

However, some Fed officials are urging caution, emphasizing that it’s premature to discuss rate cuts in March. Nevertheless, the overall consensus is that inflation is on a sustainable path towards the 2% target.

In conclusion, the Federal Reserve’s efforts to combat inflation seem to be bearing fruit without causing a severe economic downturn. Rapid rate hikes, coupled with other factors like supply chain improvements and moderated wage growth, have contributed to this success. While challenges remain, including potential housing-related inflation, the central bank’s projections and economists’ confidence suggest that inflation is gradually coming under control. This outcome provides hope for achieving an “immaculate disinflation” scenario, where inflation is defeated without triggering a recession.

Frequently Asked Questions (FAQs) about inflation control

What is the current state of inflation in the United States?

Inflation in the United States has been on a declining trend, with the most recent data indicating that it has dipped below the Federal Reserve’s 2% target. This comes after a period of significant inflationary pressures.

What factors have contributed to the decline in inflation?

Several factors have played a role in the decline of inflation. The prices of goods, including used cars, furniture, and appliances, have fallen for six consecutive months. Improved global supply chains have also helped stabilize goods prices compared to the previous year. Additionally, housing and rental costs, which had been driving inflation, are growing at a slower pace. Wage growth has cooled down as well, reducing the pressure on businesses to raise prices to cover labor costs.

How has the Federal Reserve responded to this inflation trend?

The Federal Reserve has taken note of the declining inflation and has discussed the prospects of rate cuts at recent policy meetings. This represents a significant shift from the rate-hiking campaign that the Fed had initiated earlier. They are now projecting three rate cuts for the next year, signaling a more accommodative stance to support economic stability.

Is the decline in inflation expected to continue?

While there is optimism about the progress in controlling inflation, the Federal Reserve and economists remain cautious. They want to see further evidence of sustained inflation decline before declaring victory. Challenges, such as potential inflation related to housing costs, still exist, but the overall consensus is that inflation is gradually coming under control.

What impact has this development had on financial markets?

The recent developments have had a positive impact on financial markets, with stock market indexes surging. There is growing anticipation that the first rate cut could occur as early as March, with expectations of a total of six cuts in 2024. However, some Fed officials caution that it’s premature to discuss rate cuts in March, emphasizing the need for continued monitoring.

Can we expect a recession despite the decline in inflation?

The decline in inflation, coupled with the Fed’s accommodative stance and other supporting economic trends, has reduced the likelihood of a recession. The economy has continued to grow, defying earlier fears that higher borrowing rates could trigger a recession. Retail sales data also indicates consumer spending is on the rise, which could further support the idea of achieving a “soft landing” scenario, where inflation is defeated without a recession.

How have the Fed’s rate hikes contributed to inflation control?

The Federal Reserve’s rapid rate hikes, which occurred at a historically fast pace, are credited with contributing to the decline in inflation. These rate hikes helped keep Americans’ inflation expectations in check, preventing them from taking actions that could have further fueled inflation, such as demanding higher wages.

What potential risks could impact the decline in inflation?

One potential risk is related to rental prices. Real-time measures show slow growth in apartment lease costs compared to the previous year, which could take time to reflect in government figures. A shortage of available homes may raise housing costs in the coming years, potentially keeping inflation elevated.

How confident are economists in the Federal Reserve’s inflation control efforts?

Economists have become more confident in the Federal Reserve’s ability to control inflation. While caution remains, there is a growing belief that inflation is gradually returning to the 2% target. The majority of Fed policymakers have revised their projections downward, indicating a lower probability of inflation flare-ups.

What is the outlook for inflation in the global context?

Inflation is moderating in other parts of the world as well, as seen in the actions of central banks like the Bank of England and the European Central Bank, which have kept their benchmark interest rates unchanged. This reflects a global trend of cooling inflation, although it varies in different regions.

What is the significance of achieving “immaculate disinflation”?

“Immaculate disinflation” refers to the achievement of defeating inflation without causing a recession. It is seen as a desirable economic outcome because it allows for price stability and economic growth without the negative consequences of a recession, such as job losses and economic downturns.

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