Still, the overall inflation story is simple: Many of the supply-side factors that drove prices higher earlier in the recovery are now being reversed. Notably, the CPI gasoline index plunged by 7.7% in July, and private indices suggest a comparable decline in August. Again, this price reversal was predictable and predicted; the only uncertainty concerned the timing.
Other prices are following a similar pattern. In July, the core CPI (which excludes energy and food) rose by a relatively modest 0.3%, and the core PCE deflator rose by just 0.1%. That suggests an easing of the backlog of imported goods—the problem behind those empty store shelves and business disruptions earlier in the pandemic.
Recent data support this inference. The Federal Reserve Bank of New York’s Global Supply Chain Pressure Index has fallen sharply from its peaks last fall to just above where it was before the pandemic. While shipping costs are still well above their pre-pandemic levels, they are down almost 50% from last fall’s peaks and likely to keep falling. After soaring during the pandemic and in the early months of Russia’s war, the prices of a wide range of commodities have fallen back to pre-pandemic levels. The Baltic Dry Goods Index, for example, is now below its average level for 2019.
Auto manufacturers have also overcome the problems created by the worldwide semiconductor shortage. According to the Fed’s own industrial production index, motor-vehicle output was actually above its pre-pandemic level as of July.
After a year of getting a lot of bad news about inflation and the supply-side factors behind it, we are now starting to get a lot of good news. And while no one would suggest that monetary policymaking should rest on just two months of data, it is worth noting that inflation expectations have also moderated, with both the University of Michigan Consumer Sentiment Index and the New York Fed’s Survey of Consumer Expectations edging downward in July.
The standard justification for Fed policy tightening is that it is needed to prevent a cycle of self-fulfilling expectations, with workers and businesses coming to expect higher inflation and setting wages and prices accordingly. But this cannot happen when inflation expectations are declining, as they are now.
Some analysts have suggested that the US needs a long period of higher unemployment to get inflation back down to the Fed’s target level. But these arguments are based on the standard Phillips curve models, and the fact is that inflation has parted ways with the Phillips curve (which assumes a straightforward inverse relationship between inflation and unemployment). After all, the large rise in inflation last year was not due to a sudden large drop in unemployment, and the recent slowdown in wage and price growth cannot be explained by high unemployment.
Given the latest data, it would be irresponsible for the Fed to create much higher unemployment deliberately, owing to a blind faith in the Phillips curve’s ongoing relevance. Policymaking is always conducted under conditions of uncertainty, and the uncertainties are especially large now. With inflation and inflationary expectations already dampening, the Fed should be assigning more weight to the downside risk of additional tightening: namely, that it would push an already battered US economy into recession. That should be enough reason for the Fed to take a break this month.