USM Professor Provides Perspective on Recent Inflation Cooling

Wed, 07/19/2023 - 04:41pm | By: Van Arnold

U.S. consumers learned some encouraging news recently as the annual inflation rate slowed to 3 percent in June. That number represents a drastic cooldown from June of last year, when surging energy costs caused an inflation spike of 9.1 percent – the fastest annual rate since November 1981.

Inflation, as measured by the Consumer Price Index, has now eased for 12 consecutive months and is at its lowest rate since March 2021. In addition, inflation decreased from its annual inflation rate of 4% in May.

Dr. Christopher Smith, Assistant Professor of Economic Development at The University of Southern Mississippi (USM), notes that important benchmarks must still be met before inflation can be considered under control.

“Core inflation, which excludes food and energy items, has declined by much less than inflation for all consumers,” said Smith. “It is at 4.8 percent, which is much higher than the Federal Reserve’s 2 percent target. Drilling down, it appears that inflation in the services sector is proving stickier than in the goods sector.”

Economists focus more on "core" inflation as it presents a truer gauge of price increases.

Added Smith, “The key to whether the overall disinflation trend continues probably lies in what happens to service prices. If we see some loosening of the labor market or a weakening of consumer spending, we will likely see further disinflation in services, and therefore in the overall economy.”

According to the Bureau of Labor Statistics, employers ended up adding an unprecedented 4.5 million jobs in 2022. But at the same time, millions of Americans have been leaving the labor force since before the COVID-19 pandemic. In fact, there are nearly two million fewer Americans participating in the labor force today compared to February of 2020.

The role COVID-19 played in causing inflation to soar cannot be understated. Smith explains that the pandemic triggered a fiscal and monetary policy response that pumped a lot of liquidity into the economy.

“It also caused severe labor shortages and global supply chain disfunction,” said Smith. “When demand and supply conditions such as these converge as they did, inflation is likely to result. That said, the War in Ukraine should not be overlooked for contributing to the intensity of inflation over the past year.”

Inflation has cooled since hitting its highest levels in four decades last year, partly in the face of higher interest rates engineered by the Federal Reserve, which have made it more expensive for consumers and businesses to borrow money. With the Fed’s 2 percent target still not in sight, the central bank has hinted that additional interest rate increases are possible.

Smith points out that the Fed faces a dilemma. On one hand, the central bank remains committed to lowering inflation to its historic 2 percent target. On the other hand, the Fed is also seeing evidence of a very tight labor market, which historically correlates with elevated inflation.

“The Fed also needs to continue to signal to the financial markets that it is serious about raising interest rates to achieve 2 percent to deter investment activity that might cause too much appreciation in asset prices, which can also contribute to inflation,” said Smith. “However, they do not want to cause a (deep) recession either. Further raising interest rates will reduce access to credit for businesses and consumers, which carries the risk of inducting a recession.”

The next Federal Open Market Committee meeting is set for July 26-27. Will we see another interest rate hike?

“It seems likely, despite a favorable disinflation trend in overall inflation, they will be concerned enough by the elevated level of core inflation and the tightness of the labor market to hike rates again,” said Smith.

Smith offers some fundamental advice for consumers as they continue to battle high prices for goods and services.

“One of the more concerning trends in the economic data is rising consumer credit card debt,” he said. “People should be careful about using credit cards to make ends meet because if your credit card has a variable annual percentage rate (APR), your interest rate and minimum payment are also increasing in this environment.”