Why Is the Federal Reserve Still Concerned With Inflation?

Chief Economist Eugenio J. Alemán discusses current economic conditions.

The U.S. rate of inflation has continued to come down, with the price index for Personal Consumption Expenditures (PCE), which is the preferred inflation rate as well as the target rate of inflation used by the Federal Reserve (Fed) to conduct monetary policy, hit 2.6% on a year earlier basis in December of 2023, down from a 40-year high of 5.5% in March of 2022. The Fed has established a target for the PCE price index of 2% over the longer run so although the PCE price index has had a 2-handle for the last several months, the Fed is still, by paraphrasing Chairman Jerome Powell, “not convinced” that the rate of inflation is guaranteed to continue to come down and hit the 2% target.

Following a question regarding the Fed’s current concerns with inflation during the press conference immediately following the Federal Open Market Committee’s (FOMC) decision in January, the Fed Chairman said that he “was not concerned with an acceleration in the rate of inflation but with inflation remaining above the Fed’s 2% target.” He also said that while goods prices were doing their part in helping bring inflation down, continuous weakness in those prices was not guaranteed. Furthermore, we assume that they needed to be sure that goods prices were not going to start increasing again while, at the same time, seeing some further weakness in services prices.

Total Lending Table, PCE Price Index

That is, the Fed continues to be concerned with services prices and particularly, we think, with housing prices. Although there are several measures of shelter costs that have come down considerably over the last year or so, the regained strength in home prices during the last 6 months or so, as measured by existing as well as new home prices, are one of the biggest threats to inflation if the economy continues to grow. Furthermore, the recent decrease in mortgage rates could put further upward pressure on home prices as it is expected that housing demand could start improving once again.

The graph below shows that although housing prices are already coming back down, they remain very high and any reversal in housing prices down the road could be a threat to achieving the 2% target, especially if goods prices also start to go up going forward. This is probably the reason why Fed officials are still concerned with inflation today.

Total Lending Table