The Fed Has Good Reasons to Slow Rate Increases

Finally, we seem to be getting some good inflation news. The market’s euphoria on Nov. 10, when the October consumer-price index came in below expectations, was undoubtedly excessive. But don’t let that obscure the good news, which was about more than one month.

The annualized CPI inflation rate over the past four months is now merely 2.8%. Over the four months before that, it was 12.2%. Four months is better than one, though still far too short to declare a trend. No one should think inflation has fallen durably by more than 9 percentage points. A more realistic indicator may be the 12-month inflation rate, which stands at 7.7% vs. 9.1% four months ago. It’s progress.

How should the Federal Reserve, which is far less mercurial than the markets, view this progress? As

Yogi Berra

once famously advised: When you come to a fork in the road, take it. The recently released minutes of the Federal Open Market Committee’s meeting earlier this month show that many members believe they may be at such a fork now—and that it may be time to slow down its breakneck pace of rate increases.

Remember, the Fed has been playing catch-up since March. The upper limit of its target range for the federal-funds rate now stands at 4%, up from 0.25% when it started. The last time the committee announced its multiyear intentions, after its September meeting, it expected to top out in the 4.5% to 4.75% range, although Chairman

Jerome Powell

has since suggested its internal views have shifted up.

Suppose you are thinking of topping out at 5% or 5.25%, and you are already at 4%. Continuing with 75-basis-point increments a meeting would seem a bit much, as the FOMC recognizes. It looks like time to slow down, to “taper” the pace of rate increases. The Fed isn’t yet on the verge of stopping. But the time seems ripe to contemplate a downshift, perhaps to 50 basis points or—dare I say it?—even to 25 at the Dec. 13-14 meeting. The committee gets to see one more CPI report before deciding. Let’s hope the report extends the “lower inflation” winning streak to five months.

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In addition, several members of the FOMC, including Mr. Powell and Vice Chairwoman

Lael Brainard,

are already talking publicly about the long lags in monetary policy. That’s another dovish sign. Why?

Prior to the pandemic, which rudely turned the lights out, we used to think of lags of about a year or two between a change in the federal-funds rate and its major effects on real gross domestic product—and then another year or so before inflation responded strongly. If those pre-pandemic estimates still apply, we are now experiencing the earliest small traces of the Fed’s tightening. Much more is in the pipeline.

Failure to account for these pipeline effects raises the danger of overshooting—of continuing to raise rates for too long, thereby grinding the economy into the ground. Fortunately, many members of the FOMC understand that danger, which is one reason why I expect the 2023 recession to be mild.

Slowing rate increases is one thing; stopping them is quite another. The Fed will need much more evidence that inflation is on the decline before it stops raising rates. And so far such evidence is scant. The 12-month annual rate of 7.7% is better than its peak of 9.1%, but still much too high.

If we look instead at the Fed’s preferred measure—the deflator for core personal consumption expenditures, or PCE, which excludes food and energy prices—we find lower measured inflation but little disinflationary progress. Core PCE inflation over the past 12-month period (ending in September) was 5.1%, about where it has been since April, though it briefly dipped a bit lower.

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Three special factors, apart from excessive aggregate demand, have driven inflation up since 2021: energy prices, food prices and supply-chain bottlenecks. In their quest to reduce inflation, the Fed and other central banks have received little to no help on the first two. At long last, however, supply bottlenecks show signs of abating. The average wait time for a shipping container to be picked up after being unloaded at major West Coast ports has fallen by more than half since last fall. Over that same period, the cost of getting that container there from, say, China, has dropped like a stone. Those and similar developments will gradually ease core inflation.

So yes, there is some good news on the inflation front, which markets have naturally exaggerated. The more sober-minded Fed sees this good news but realizes it still has some heavy lifting to do. The rest of us should take solace in the knowledge that the central bank is trying not to overdo it and wish it good luck.

Mr. Blinder, a professor of economics and public affairs at Princeton, served as vice chairman of the Federal Reserve, 1994-96. He is the author, most recently, of “A Monetary and Fiscal History of the United States, 1961-2021” (Princeton University Press).

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