Inflation below 2%: Here’s why it might happen
For the better part of three years, high inflation has been the United States' predominant economic problem. While it's unlikely, there is perhaps a chance that prices could fall below the Federal Reserve's target.
Why it matters: To the extent that inflation risks become more symmetrical in 2024 — with "too-low" a possibility alongside "too-high" — it would mean some relief to consumers, and make the Fed more open to significant rate cuts.
State of play: The Fed's favored inflation measure, the Personal Consumption Expenditures Price Index, has fallen precipitously from 7.1% at its 2022 high to 2.6% for the 12 months ended in November.
- The low-hanging fruit of inflation reduction has been eaten — particularly with commodity prices coming into line. But there could be room for key drivers of prices to come down further, even absent a recession.
What they're saying: Goldman Sachs economists wrote recently that they see core PCE inflation below 2% as "a plausible outcome for 2024."
- A key open question has been whether physical goods prices have further to fall, given how much supply chain repair has already occurred.
- "We find that price levels in several supply-constrained categories remain elevated, both relative to the pre-pandemic trend and relative to the cost of production," wrote Goldman's Spencer Hill.
- "In a scenario where consumer goods margins normalize and core services categories do not reaccelerate, we forecast year-on-year core PCE inflation would drop to 2.0% year-on-year in May and to 1.9% in December," he adds.
Between the lines: That scenario wouldn't be a radical one for how people experience economic conditions. In terms of how things feel, 1.9% inflation isn't much different from 2.1%.
- But it would meaningfully increase the Fed openness to significant easing. And that's even before accounting for more severe disinflation or deflationary scenarios, which could be triggered if the United States falls into recession.
Yes, but: The possibility of below-target inflation doesn't appear to keep Fed officials awake at night. According to minutes of the December policy meeting released yesterday, the staff's stance is that inflation risks are "skewed to the upside."
- Moreover, "several participants assessed that healing in supply chains and labor supply was largely complete, and therefore that continued progress in reducing inflation may need to come mainly from further softening in product and labor demand."
The bottom line: In 2022 and 2023, the name of the game for policymakers was bringing down inflation at any cost. Now, we could be entering a year of greater nuance and policy symmetry.