I had the great Charles Kindleberger teach me international economics a long time ago. Kindleberger is famous for his quotes as much as his insights. One of the things that stuck with me was, he was talking about the balance of payments, but it applies to many areas of economics as well: people always want a single number, but what they really want is a story.
The same goes for the current issue of inflation: there are different measures of inflation, and, to quote another Kindleberger joke, you can always find a way to justify optimism or pessimism depending on your temperament. But what about in reality?
I would argue that the answer is that after a few turbulent months at the beginning of this year, last year’s big story of a “perfect disinflation” — that is, that inflation was gradually falling to tolerable levels without the recession that some economists argued we needed — is back on track.The big question now is whether we will have a recession after all, now that we know we didn’t need one.
What is the basis for my claim? As I said, there are many measures of inflation. These measures tend to give the same results when things are very bad and when things are very good. When inflation was very high in the 1970s, all the measures showed that inflation was very high. During the long period of relative stability from the mid-1980s until the 2008 financial crisis and through much of the 2010s, all the measures showed that inflation was fairly low.
In the post-COVID turmoil, things are even messier: inflation measures can diverge depending on how they treat things that are hard to measure, like the prices of financial services and, most notably, house prices (which appear to reflect market conditions over a long time lag).
That said, there is every reason to focus on measures favored by the Federal Reserve, which has years of experience in making inflation-related policy decisions. Let me offer a few variations.
First, there’s Core Market-Based Personal Consumption Expenditures, a measure cited approvingly by Federal Reserve Chairman Jerome Powell. With a bit of interpretation, “core” means that it excludes volatile food and energy prices, and “market-based” means that it excludes items that don’t actually trade in the market but whose prices are purely estimated. Below is the inflation rate of this price index over the past year, measured at two frequencies: monthly annualized rate and year-over-year rate.
As we can see, the inflation rate measured monthly (blue trend line) is very unstable and it is always difficult to determine whether the large fluctuations represent real changes or just statistical noise. The price spike at the beginning of 2024 created a lot of uncertainty: was inflation rekindling or was this simply companies resetting prices at the beginning of the year, a phenomenon that should be corrected in “seasonally adjusted” data, but may not have been sufficiently corrected. The subsequent drop in inflation led to the widespread interpretation that this was a statistical temporary fluctuation. In fact, the annual inflation rate (red trend line) continues to fall steadily.
After all, one thing that “market-based” inflation still includes is the estimated cost of owner-occupied housing. As many of us have noted, the official measure of housing costs is a very lagging indicator, reflecting rent increases that ended a year or more ago. So it might make sense to exclude housing costs from the inflation measure — not because housing costs aren’t important to families, but because a measure that excludes housing might be a better predictor of future inflation. Then the graph above would look like this:
By this measure, inflation is already close to the Fed’s 2% target rate on both a monthly and annual basis.
There are other indicators, of course. Previously, I cited the New York Fed’s estimate of multivariate core trend inflation, which has been revised upwards and briefly rose earlier this year before reversing its rise and now stands at 2.8%. Goldman Sachs’ own measures are more optimistic, showing it very close to the Fed’s target.
Given the incomprehensibility of the official inflation numbers, I think it’s also useful to look at the soft evidence: what companies are saying. The Fed periodically surveys companies across the country and publishes its findings in the Beige Book. The latest version says that “prices rose at a moderate pace during the reporting period.” How does this differ from what was said in the report on the eve of the COVID-19 pandemic, when everyone thought inflation was well under control? The wording in the January 2020 version is almost identical: “prices continued to rise at a moderate pace during the reporting period.”
Overall, underlying inflation is probably between 2 and 3 percent, and the spike earlier this year appears to have been a misreport. We don’t know if inflation has fully returned to its traditional (but arbitrary) target, but it doesn’t look like inflation is a major concern at this point.
But I am starting to get a little worried about the economic slowdown.
There’s nothing to suggest an “imminent recession,” but the signs are there. Inflation-adjusted consumer spending fell slightly in April. A widely watched manufacturing report suggested signs of weakness. Again, not enough to sound the alarm yet, but the balance of risks is clearly shifting.
So it’s time to stop obsessing about inflation, which increasingly seems like yesterday’s problem, and start worrying about a possible recession as the economy finally begins to weaken under the weight of high interest rates. So I think the Fed should start cutting interest rates. And soon.
Quick Hit
When were the good old days?
Murders are falling sharply.
Economic news coverage may become more active again.
Social mobility is declining.
