Kuttner on TAP: Inflation Is Actually Subsiding

Are financial markets, pundits, and policymakers overreacting to the August inflation numbers? There’s a reasonable case that they are.

There are two basic indicators here—the month-over-month number, and the one-year comparison. August prices compared with July prices were up just one-tenth of 1 percent, this after the July price average was unchanged relative to June. However, if you compare August 2022 to August 2021, the Consumer Price Index is up 8.3 percent.

The big question here is the trend. Two well-informed inflation doves, who break with the conventional wisdom, are Jan Hatzius, chief economist of Goldman Sachs, and Paul Krugman of CUNY and The New York Times. Both find inflation easing based on a variety of indicators and the economy heading for the proverbial soft landing without a recession—if the Fed doesn’t screw things up with excessive interest rate hikes.

Hatzius, who has an excellent track record for prediction, makes the following points: The spread between regular bonds and inflation-indexed bonds projects just 2.4 percent inflation over the coming five years, based on investor expectations.

Further, supply chain dislocations were so extreme that they produced wild supply-demand imbalances and price jumps in such sectors as used cars. As supply chains normalized, prices have come right back down. In August, the average price of used cars declined slightly.

Both of these indicators cited by Hatzius suggest that we are a long way from inflation expectations being “embedded” in the economy, the prime contention of the inflation hawks.

In addition, Hatzius points out that the economy is already on track for slower GDP growth. Growth was slightly negative in the first half of 2022, and Goldman projects that it will be just 1.25 percent in the second half, easing demand pressures. In other words, a soft landing without a recession.

Krugman adds the insight that “In April, according to the New York Fed, consumers expected 3.9 percent inflation over the next three years; that’s now down to 2.8 percent, and only 2 percent over the next five years.”

That same 2 percent is the Fed’s long-term inflation target. It will certainly take some time for the Consumer Price Index to get back to that figure. But if the number keeps heading downward, the Fed can surely live with a moderately higher rate in the interim.

Except for the dramatic fall in gas prices—from a peak of $5.02 to $3.71 for a gallon of regular—Biden doesn’t have bragging rights, yet. But the trend is heading in the right direction. Unfortunately, both the stock market and the coven of financial writers are subject to herd instincts, and self-fulfilling prophecies do damage.