07-11-2024
Investors, markets and the public will comb through today’s Consumer Price Index (CPI) inflation report released by the Bureau of Labor Statistics to see if details in the report shed any light on the future path for interest rates. In their June 12 policy statement, the Federal Open Market Committee (FOMC) indicated that a condition for the committee to begin to reduce their policy rate is that they have “… gained greater confidence that inflation is moving sustainably toward 2 percent.” While the FOMC measures inflation using the Personal Consumption Expenditure (PCE) index, data on the CPI is released earlier and the two inflation measures tend to track each other with CPI inflation on average 0.4 percentage points higher than PCE inflation. The CPI report provides an earlier look at the next reading on PCE inflation.
The FOMC began raising its policy rate this cycle back in March 2022. At that time, overall PCE inflation was 6.6 percent and “core” PCE inflation (that removes food and energy inflation) was 5.2 percent. The FOMC reached its current level of 5.25-5.5 percent for its policy rate in July 2023 when PCE inflation was 3.3 percent and core PCE inflation was 4.2 percent. If policy was well calibrated in July 2023, then an important question is why was policy still well calibrated in June when PCE inflation was 2.7 percent and core PCE inflation was 2.8 percent? Over the same time period, the unemployment rate rose from 3.5 percent to 3.9 percent.
Transparency of monetary policy is important to allow markets to better anticipate and therefore price future changes in monetary policy into longer-term interest rates. An alternative to calibrating monetary policy based on confidence over the future path of inflation is to adjust the policy rate to recognize progress already made on inflation. It would be easier for markets to anticipate monetary policy that reflects progress toward the FOMC’s inflation objective than to divine the committee’s degree of confidence around this path.
Joseph Tracy is a Distinguished Fellow at Purdue University’s Daniels School of Business and a nonresident senior fellow at the American Enterprise Institute. Previously he was executive vice president and senior advisor to the president at the Federal Reserve Bank of Dallas.
