Opinion: 3 things the Fed needs to see before it stops raising rates

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Publisher’s note: Joseph H. Davis is Vanguard’s Chief Global Economist. The opinions expressed in this comment are his own.

The Federal Reserve is aware of the pain that spiraling prices are causing Americans. At the recent Jackson Hole Economic Symposium, Fed Chairman Jerome Powell said reducing inflation “will also bring some pain to households and businesses.” But what the nation’s central bankers are hesitant to discuss is what they would define as success in fighting inflation and, in turn, when they would be willing to stop raising interest rates.

Clearly, the Fed still has work to do. The last inflation The report showed that prices for consumer goods and services were 8.3% higher, on average, year over year in August. While this represents a decline from the previous reading, it shows that, at that level, consumers’ purchasing power is still being eroded because wages are not keeping up with price increases. the broad united states Values Y link markets have posted double-digit losses over the past 12 months, leaving investors’ portfolios even further behind in real (inflation-adjusted) terms.

As I mentioned before, the fed it will continue to raise its benchmark interest rate until inflation enters a sustained downward path, falling below wage growth and approaching the central bank’s long-term target of 2%. But falling inflation alone cannot end the Fed’s campaign. Instead, policymakers are likely to take a more nuanced approach. I think they will keep raising rates until they are satisfied that so-called “flexible pricing” and “sticky pricing” are under control. They will also want to see evidence that consumers believe spiraling prices are in the rearview mirror.

In the past six months alone, the Fed has raised the upper bound of its short-term target range Interest rates 10 times: from 0.25% to 2.50%. Far from being subtle, it has been one of the most aggressive moves in monetary policy in US history.

Before the Fed slows down the pace and size of interest rate hikes, it will probably want to see three to six months of sustained slowdown in flexible prices, which apply to goods and services whose cost can rise or fall rapidly. These include things like food, energy, and cars and trucks.

This day, gasoline prices have been moving in the right direction, but most flex-price items remain high. Policymakers are almost certain to continue hiking rates next week, raising the upper bound of their target to 3% or 3.25%.

Once policymakers are comfortable with the direction of soft prices, they will want to make sure that sticky prices are heading towards their goal as well. They are similar, though not the same, to so-called core inflation measures, which exclude food and energy prices. Fixed prices apply largely to services like rent and health care. They don’t tend to change as much or as quickly as flexible pricing.

While the owner inflation has been declining, the trend between sticky prices and core inflation measures has not yet changed. Shelter Y health care servicesfor example, they continue to experience price increases of approximately 6% year over year.

Inflation expectations are key because they affect consumer and business spending and investment decisions that drive the economy. Median inflation rates expected for the next 12 months have been reduced to 5.7%, according to the Federal Reserve Bank of New York, below the 6.2% of the previous month. And they are at 4.8% as measured by the University of Michigan, below 5.2%. For now, inflation expectations are neither raising alarm bells nor pushing the Fed to raise policy rates any faster, but the Fed would like to see them fall closer to 2%.

Given my belief that the Fed will want to see signs of success in its campaign on three fronts, not only against flexible prices but also against sticky prices and inflation expectations, it could be a while before policymakers declare the victory in his campaign against inflation.

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