With the Federal Reserve at last reversing course and lowering short-term interest rates by 50bps this week, we can officially say that a chapter of US economic history has ended. Inflation - the economic monster-under-the-bed, the Sauron of macro, the bogeyman of governments everywhere since the early 20th century, and the purported source of all woes since the orgy of federal pandemic spending in 2020 and 2021 – has receded close to its startlingly low levels of the 2010s. In short, inflation is over.
You wouldn’t know that by listening to voter concerns. Inflation and cost-of-living remain high on the agenda of top issues. But as we know from past experience, public attitudes lag public data, meaning that it takes anywhere from 6 to 12 months after the data has registered meaningful shifts before people begin to adjust their views. That’s why so often people believe that the economy is negative many months or even a year after it started becoming negative and remain convinced that the trends are negative many months after it begins to turn positive.
Inflation clearly was a significant shock from the middle of 2021 until the last half of 2023. Whether measured by the traditional consumer price index (CPI) or the preferred Personal Consumption Expenditure index (PCE), inflation went from less than 2% in 2019 to more than 8% (CPI) in mid-2022. The pocket-book reality was felt acutely in food prices, which along with gas prices are the most obvious day-to-day experience most of us have with rising or falling prices. In August of 2022, food inflation, both at home in terms of grocery prices and at restaurants and take-away food, reached 11%, which was the highest it had been since 1979.
While actual wages and take-home pay for the vast majority of Americans also went up between late 2020 and late 2022 care of massive government spending and child-tax credits, those increases weren’t enough to offset inflation overall. Hence the widespread anger and panic about untenable cost of living. Add to that the fact that there was one weird effect of the Fed starting to raise interest rates in 2022: when the Fed raises rates aggressively, the housing market tends to freeze. After all, why buy a home when mortgage rates are going up if you can wait? People need somewhere to live so they tend to rent while they are waiting out the mortgage cycle. That then puts pressure on rentals, and indeed, rents went up a lot in 2021-2023, in many areas at the fastest pace in a hundred years! And when rents go up, inflation as measured by the government also goes up, because rent is about 30% of the CPI. So, one weird effect of the Fed raising interest rates to fight inflation is that it actually causes some short-term inflation in the form of higher rents.