When it comes to the Federal Reserve’s interest rate policy, what inflation is doing now matters far less than what it is doing next spring.
What inflation is doing right now is going on very high. The Labor Department reported Tuesday that the index for consumer prices rose 0.3% seasonally from July to August, putting it up 5.3% from its year-ago level. Basic prices excluding food and energy items were 4% higher than a year ago in an effort to better capture the trend of inflation.
A separate Commerce Department measure of inflation that the Fed prefers tends to run slightly cooler, but Tuesday’s report suggests it was well above the 2% targeted by the central bank.
Still, August’s inflation rate has little bearing on the Fed’s near-term plans at this point. The central bank appears to have set a course at its November meeting to reduce its monthly bond purchases, which will be completely phased out sometime in the middle of next year. Inflation measures are unlikely to show either a massive cooling or a massive acceleration between now and November, so the only thing that could really delay the start of tapering is a really shoddy employment report.
Part of the way Fed officials want to taper off is that they don’t want to buy assets even when they start raising rates. So the sooner they end the central bank’s bond purchases, the sooner they have the option of tightening up.
Whether they start raising rates once they end tapering seems to depend largely on what inflation is doing at the time. That’s where the question of how recent consumer prices have risen is fleeting.
Tuesday’s report showed that some issues related to the pandemic have pushed prices up, in fact, starting to fade. For example, the prices of used cars and trucks fell 1.4% in August from July, and it looks like they will register further declines. Car rental prices fell 8.5% on the month.
Other prices could cool by next spring, when the debate over what the Fed should do about rates becomes more pressing. The global chip shortage that has stalled production of cars and other goods should have subsided by then. The same goes for other supply-chain bottlenecks that work their way into prices.
But even if the world is in a better place with COVID-19, some pandemic-related friction may continue. In addition, the continued hardships that employers are having to fill positions are likely to keep wages at a higher level, and those higher labor costs may work their way into prices.
As long as it is done with tapering, the risk is that the Fed is no longer debating whether it should start raising rates, but by how much.
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