US Inflation Progress Gets Harder in Last Mile Down

Despite a significant decline in US inflation over the past year, the final stages of disinflation are proving to be a challenging task. While headline inflation has eased, core inflation remains stubbornly high, posing a hurdle for the Federal Reserve in its quest to achieve a soft landing for the economy. This article explores the factors contributing to the persistence of inflation in the services sector, the role of geopolitical factors in hindering disinflation, and the delicate balancing act the Fed faces in controlling inflation without tipping the economy into recession.

Supply chain disruptions and labor market dynamics are key factors contributing to the persistence of inflation in the services sector. Despite a general decline in consumer price inflation, services inflation has remained high due to the slow unwinding of supply chain snarls and healthy wage gains for workers in the service sector. The Federal Reserve's challenge lies in managing these factors while avoiding a recession, as the job market remains strong but wage growth could exacerbate inflation.
Geopolitical factors, such as energy price volatility and global supply chain bottlenecks, also pose significant challenges to the final stages of disinflation. The recent disruption to Red Sea navigation, for instance, directly impacts input and final goods prices, while also delaying their availability. Higher labor costs further exacerbate inflationary pressures, highlighting the complexity of the disinflation process.

The Federal Reserve faces a delicate balancing act in controlling inflation without tipping the economy into recession. After a sharp decline in US inflation over the past year, the latest data shows a slight pickup, with headline inflation increasing to 3.4% (FT, 2024). The Fed has raised interest rates ten times in the last 14 months to tame prices, but inflation remains stubbornly high (NPR, 2023). To achieve a soft landing, the Fed must carefully calibrate its policy tools.
Firstly, the Fed can employ forward guidance to manage market expectations. By clearly communicating its intentions and the likely path of future policy rates, the Fed can help anchor long-term interest rates and mitigate uncertainty (BCG, 2022). However, the Fed must ensure its guidance is credible and not overly data-dependent, as excessive volatility in market pricing can introduce unwanted risks.
Secondly, the Fed can use its balance sheet to provide liquidity and support market stability. By maintaining ample liquidity, the Fed can decouple market pricing from traditional economic signals, such as interest rates and inflation. This can help smooth out market volatility and reduce the risk of a hard landing (BCG, 2022).
Lastly, the Fed can consider unconventional tools, such as quantitative easing (QE) or targeted lending facilities, to support specific sectors of the economy. These tools can help mitigate the impact of higher interest rates on vulnerable sectors, such as housing or small businesses, and promote a more balanced recovery (BCG, 2022).
In conclusion, the Federal Reserve must navigate a challenging path in controlling inflation without triggering a recession. By employing forward guidance, managing its balance sheet, and considering unconventional tools, the Fed can strive for a soft landing and support long-term economic growth. However, the Fed must remain humble and adaptable, learning from past experiences and reassessing its strategies as needed. As the US economy faces headwinds in the final stages of disinflation, policymakers must remain vigilant and responsive to the evolving economic landscape.