Even if low inflation persists, it might not count as a reason for the central bank to cut rates.
By Justin Lahart
Federal Reserve Chairman Jerome Powell Photo: Mark Wilson/Getty Images
The Federal Reserve is worried that even as the economy continues to do well, inflation is running cold. So what, if anything, should the central bank be doing about its dilemma?
For now, the Fed is sitting on its hands. Its policy-setting committee left interest rates unchanged at the end of its two-day meeting Wednesday, and it reiterated its pledge “to be patient” on adjusting rates in the future—a signal it will likely stay on hold when it next convenes in June.
But the Fed did note that inflation slipped in the first quarter. This is a concern. By the Fed’s preferred measure, consumer prices excluding food and energy—the so-called core—were up 1.6% from a year earlier in March. That compares with a year-over-year gain of 2% in December.
The first-quarter cool-down makes it unlikely that core inflation will reach 2% again by the end of the year. Indeed, if core prices increase at a 2% annual rate in each of the final eight months of 2019, core inflation still would only reach 1.7% in December.
The Fed has an inflation target of 2% but, after years of mostly falling short of that mark, the central bank increasingly has become worried that too-low inflation is becoming ingrained in consumer expectations. Since expectations feed into actual prices, the risk is that inflation will remain persistently below the Fed’s target. That would be problematic if a recession were to hit since deflation, or falling prices, would be that much closer. (Hello, Japan.)
So the Fed might end up lowering rates in an attempt to push inflation higher. Some investors seem to think this is possible: Interest-rate futures imply there is a better-than-even chance of a rate cut by year-end.
But the drop in inflation may owe more to idiosyncratic factors than a general cooling. Morgan Stanleyeconomists note that a variety of alternative inflation measures that exclude items with the most extreme price increases and decreases suggest there has been little change in inflation’s underlying trend this year. Moreover, with a strong job market likely to push the unemployment rate even lower in the months ahead, worries about low inflation might not persist.
Or perhaps inflation will stay stuck below 2% even if the economy does well. The question then would be whether rate cuts would successfully push prices higher or simply bring rates closer to zero, leaving the Fed with nothing to show for its efforts.
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