The Inflation Picture Isn’t as Negative as Republicans and the Markets Are Saying

With the announcement on Tuesday that consumer-price inflation had been higher than expected in August, the recent string of positive economic news for Joe Biden and the Democrats came to an end. The headline inflation rate declined from 8.5 per cent in July to 8.3 per cent last month, the latest Labor Department report shows, but the core rate, which excludes volatile energy and food prices, increased from 5.9 per cent to 6.3 per cent as the cost of rent, new cars, and other items rose in what the report called a “broad-based” increase. Economists and the Federal Reserve monitor the core rate closely, because they believe it gives an accurate picture of underlying trends. The central question now is whether the Fed chairman, Jerome Powell, and his colleagues will raise interest rates more aggressively to temper inflation—a step that could inadvertently tip the economy into a recession.

The inflation report prompted a big sell-off on Wall Street: stocks suffered their biggest drop in more than two years. However, amidst renewed criticism of the Biden Administration from Republican leaders, the Consumer Price Index (C.P.I.) report needs to be put into perspective. Despite some concerning features, it did confirm that over-all inflation pressures are gradually easing, although not as rapidly as many consumers would like to see. In June, the headline rate was 9.1 per cent, so in two months it has declined by 0.8 percentage points. And, even though the core rate rose, there are reasons to believe it will fall considerably in the coming months. “Big picture, the core C.P.I. rate is still slowly coming down,” Ian Shepherdson, a chief economist at Pantheon Macroeconomics, told me. “I have no doubt it is going to come down considerably over the next six months.”

As Biden was quick to point out, gas prices dropped sharply over the summer. Where prices go from here depends on what happens in the global oil market, which is difficult to predict. But the price of crude oil fell again on Tuesday, and, if this continues, prices at the pump will keep trending down. How far? “Barring hurricanes or unexpected outages . . . the national average could decline to $3.49, then $3.25,” Patrick De Haan, a petroleum analyst at GasBuddy, a tech company that helps people find cheap gas, told Yahoo finance. “And it’s not impossible that we could be on the road to a $2.99 national average by the end of the year.”

Cheaper gas is good news for motorists, obviously, but it also augurs well for anyone who buys food, which means practically everyone. Over the past twelve months, according to the August report, the cost of food eaten in or out of the home has risen by 11.4 per cent, the biggest annual increase since May, 1979. One of the things that propelled food prices upward was sharply higher transportation costs. With lower fuel prices, these costs are now falling, which should eventually lead to lower food prices. If it doesn’t, someone somewhere is profiteering. The same goes for airfares, which dropped 4.6 per cent last month. With the cost of jet fuel having declined sharply during the summer, fares for autumn should fall a good deal further.

Then there is the global supply-chain crisis, which is finally starting to ease. This is particularly evident in the auto industry. The last couple of years has seen a severe shortage of new vehicles, which has led to dramatic increases in the prices of used cars. More recently, however, auction prices for used cars have fallen sharply—by four per cent in August alone, according to one industry index. As yet, those lower auction prices haven’t led to a big drop in the prices that auto dealers charge for used vehicles. This should happen soon. And as used cars get considerably cheaper, that should constrain the ability of dealers to raise the prices of new ones. With vehicles accounting for about eleven per cent of the C.P.I., these developments are far from trivial.

Another factor to consider is the role that rents, which make up almost a third of the C.P.I.—i.e., a huge part of it—are playing in keeping inflation high. In the past twelve months, according to the August report, rents for primary residences have risen by 6.7 per cent. (This figure includes rents paid by people on longer-term leases, so it takes into account the much bigger hikes for new leases seen in some places, such as parts of New York City.)

Higher rents reflect multiple factors, including strong demand, a shortage of available rentals, and soaring real-estate prices, which have priced out some would-be buyers and turned them into renters. As the Fed has increased the federal-funds rate recently, mortgage rates have gone up sharply as well. As a result, home sales have slowed, and prices are now falling in many parts of the country. If they continue to drop, and they likely will, buying will become a more attractive option, which will reduce the demand for rentals. That, in turn, should put downward pressure on rents. Unfortunately, this could take a while. “While we anticipate housing cost pressures to ease in the coming months on the back of a sharp pullback in housing demand, cooler price momentum won’t be evident for a few more months,” Gregory Daco, a chief economist at EY-Parthenon, wrote in a commentary on the inflation report.

On the basis of these and other factors, including a compression of profit margins as pandemic-related restrictions on supply continue to ease, Shepherdson is predicting that by March of next year the core inflation rate will have dropped from 6.3 to 4.8 per cent. He also cited Wednesday’s release of the Producer Price Index for August, a separate report, which showed that prices at the wholesale level fell slightly over the month, and increased by 8.7 per cent on an annual basis, the smallest increase in a year. “It unambiguously showed inflation coming down across both the goods and services sectors,” he noted.

In their eagerness to shift the focus of the midterms from Donald Trump and abortion rights to inflation and the cost of living, Republicans are skating over any encouraging economic developments, of course. The danger is that with just one monthly inflation report left before voting day—it will be released on October 13th—their messaging could resonate. Although Biden’s approval ratings have rebounded somewhat in recent weeks, a new Harvard CAPS-Harris Poll indicates that fifty-four per cent of Americans still believe that their personal finances are getting worse. (Forty-six per cent of respondents said that their situation is improving or unchanged.)

With prices still rising faster than wages, these poll findings aren’t surprising. But with the over-all inflation rate declining, and with wage pressures and inflation expectations contained, there are still reasons for optimism and no justification for the Fed to panic. When Powell and his colleagues meet next week, the Fed chief should make this clear and resist calls for more drastic increases in interest rates. Getting inflation down will take some time, but the process is already ongoing.