How will we know when we’ve beaten inflation?


How will we know when we’ve beaten inflation?

For the Federal Reserve, victory over inflation is a specific mark: core inflation rising around 2 percent, the point at which interest rate hikes and other tightening will be off the table. But for consumers, what victory over inflation looks like is far from clear — and for the economy as a whole, the cost of victory might be severe.

After months of prices rising at an increasing rate, inflation may have already peaked. While the annual change in consumer prices remains high at 6.4 percent, inflation is clearly trending down, falling for six months in a row consistently from its 9 percent peak in June. A closer look at the data shows even milder price increases. If you take the last three months of inflation data and multiply it out to a year, making it comparable to what the Fed is looking for, “core” inflation (stripping out food and energy) is down to 3.1 percent, spitting distance of the Federal Reserve’s 2 percent target.

While one broad-based measure of inflation dropped below 2 percent in the mid-1980s, prices rose between 3 percent and 5 percent on an annual basis for much of the later part of the decade. The 2 percent inflation target, pioneered by New Zealand in 1990s, was only formally embraced by the Fed in 2012, although it had been the implicit target before then.

“One thing that’s been very obvious is that when inflation is in a range of 6 percent to 8 percent, it’s hard to talk about trade-offs, patience and thinking through how you land the plane,” Mike Konczal, director of economic analysis at the progressive Roosevelt Institute, told Grid. “When inflation is down in the 3 percent range, you can talk about trade-offs, how fast to get to 2 percent or an inflation target of 3 percent to 4 percent.”


“We’re never going back to the old price level”

Prices tend to rise over time — low inflation simply means they rise slowly.

While prices of goods and services linked to commodities like food and energy can move up and down, the overall price level will almost certainly not decrease. In fact, a price decrease would mean an economic catastrophe. “We’re never going back to the old price level,” former Federal Reserve economist and fellow at the Peterson Institute for International Economics Joseph Gagnon told Grid. Prices, Gagnon said, “are higher forever.”

But just because prices won’t come down doesn’t mean that consumers will be permanently worse off. While the large overall price increases the economy has experienced in the past two years are in some sense permanent, wages may eventually catch up so that the experience of higher prices becomes more bearable. “People will get raises, I do think,” Gagnon said, pointing to projections he had made for wage growth this year.

But those wages will have to keep up with prices that are likely to keep on going up, albeit more slowly.

“We might be, at the moment, around peak inflation, but probably not peak prices,” Alan Jope, the chief executive officer of the consumer goods giant Unilever, said in Davos at the World Economic Forum. “There’s further pricing to come through, but the rate of price increases is probably peaking around now.”


Some goods have seen outright price decreases in recent months. Used car prices fell 9 percent in the second half of 2002, and overall durable goods prices started falling in August. Gagnon pointed to prices of goods, ranging from appliances to furniture to cars, having risen dramatically and now starting to moderate. “There’s every reason to expect that to reverse. We’re seeing it, we have three months in a row of non-energy goods prices falling,” Gagnon said.

While the price of housing continues to rise according to the Fed’s metrics, thanks to a well-examined methodological discrepancy in how the Fed calculates housing costs, it will likely start to slow or even decline this year. “There are a lot of different metrics that show housing as measured right now has peaked and start to decline over the next six months,” Konczal told Grid.

“Does inflation stay at three or four and go back to two?” Gagnon asked. “I think this year we’ll get inflation coming down much faster than wage growth, and workers will catch up much or most of what they lost.”

The Fed’s view

For the Fed, however, it’s not about simply feeling easing pressure.

The Fed launched the most aggressive interest rate hikes in decades last year, bringing the federal funds rate — the rate it controls — from near-zero percent to over 4 percent with six straight hikes, including a 0.75 percent point hike four straight times. These hikes have had a mixed effect on the economy. They massively slowed down the housing market, bringing home prices down and mortgage payments up, taking a huge bite out of home sales. The hikes also wrenched down the stock market, which fell almost 20 percent in 2022.

The Federal Reserve has not formally committed to more hikes, but it has projected that it will get rates to above 5 percent this year, and it’s expected that it will bring up interest rates another 0.25 percent in February.

While the unemployment rate has remained low, the Fed expects it to rise by about a percentage point to 4.6 percent, translating to over 1 million jobs lost, which typically means a recession.

The Fed itself is not unified on its approach to what may be the end of its rate-hiking schedule.

“I expect that we will raise rates a few more times this year, though, to my mind, the days of us raising them 75 basis points at a time have surely passed,” Federal Reserve Bank of Philadelphia President Patrick Harker said late last week.

St. Louis Federal Reserve President James Bullard was more hawkish, telling a trade group that “it would be appropriate to get [above 5 percent] as soon as possible,” and that “the Fed is going to have to maintain rates at high enough levels” to meet its inflation goals.


The market seems to think that hikes won’t just slow but could reverse themselves, at least in part. According to data from CME Group, investors are almost certain that there will be at least two more hikes this year, but there could be interest rate cuts by the end of the year, indicating that inflation will be low enough that the Fed feels like it doesn’t have to raise rates anymore and that the economy will need of some monetary stimulus.

The last time the Federal Reserve acted this dramatically to bring inflation down was the so-called Volcker shock in the early 1980s, where interest rates got over 20 percent, the U.S. economy went through two recessions and unemployment skyrocketed.

The question now is how much pain the Fed would be willing to inflict on the economy not to bring down inflation from near 10 percent but to take it from around or even below 5 percent to closer to 2 percent — even at the risk of boosting unemployment. Until now, the burden of interest rate hikes has been largely felt by shareholders. What happens when it’s workers who pay the price?

Thanks to Brett Zach for copy editing this article.

  • Matthew Zeitlin
    Matthew Zeitlin

    Domestic Economics Reporter

    Matthew Zeitlin is an economics reporter at Grid focused on the domestic impact of major stories such as coronavirus, the supply chain and economic volatility.