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The Economy: From the Financial Times: US inflation eased last month to its lowest level in nearly two years but an uptick in core prices will keep pressure on the Federal Reserve to press ahead with another interest rate increase in May.
The IMF has warned of a “hard landing” for the global economy if persistently troublesome inflation keeps interest rates higher for longer and amplifies financial risks.
From the New York Times: Inflation has come down from its historic highs, though not far enough to stop plaguing the economy just yet.
That’s the takeaway from data released yesterday. First, the good news: Prices rose at their slowest pace in nearly two years, having climbed 5 percent in the 12 months that ended in March. The increase is still higher than the 2 percent annual rate that policymakers seek to keep the economy humming — but is down from a peak of 9 percent last summer.
The bad news is that other measures — particularly indicators that exclude food and energy prices, which are known as core inflation — tell a more mixed story. In the chart below, you can see that core inflation is more stable than overall inflation and, for that reason, is less prone to misinterpretation.
The mixed news suggests that the Fed’s recent moves have worked to tame inflation, but that more action is needed to get price increases down to sustainable levels. Today’s newsletter will break down the data and what the Fed might do next.
Mixed picture: There is an underlying story behind the numbers, starting a few years ago. Flush with money from Covid relief legislation and stuck at home during the pandemic, Americans bought more things they could use in their homes. So prices for goods — physical stuff like furniture and appliances — increased sharply over 2021.
As the economy has recovered from the Covid shock and people have started to go out again, consumer demand is shifting to services — things you pay people to do, like make food for you at a restaurant or fly you across the country. Prices are rising accordingly, particularly across airlines, transportation and restaurants, as you can see in this chart:
Source: Bureau of Labor Statistics | Chart shows percent change in prices between March 2022 and March 2023. | By The New York Times
That trend is what policymakers are looking at now. It suggests consumer demand is still too high — first chasing limited goods and now chasing limited services, leading to increases in prices.
There are some good signs for the prospect that inflation will fall further. The flood of cash that people got from the government during the pandemic is drying up, reducing consumer demand. The supply chain has largely untangled itself from the snarls of the earlier Covid days. The shock to oil and gas prices from Russia’s invasion of Ukraine has eased. The Federal Reserve, in an effort to further restrain demand, has increased interest rates to make borrowing money more expensive.
But there are also some potentially bad signs. American consumers are still spending a lot, taking advantage of higher wages and savings accumulated during the pandemic. The cartel of oil-producing countries, OPEC, is cutting its production to try to raise prices. The longer inflation persists, the more likely it is to become ingrained in the economy — making it more difficult to bring down further. “It’s not that inflation is going to take back off and spike again, but that we might not be able to fully stamp out what remains of it,” Jeanna said.
What’s next? Going forward, policymakers will probably try to take a balanced approach to match the mixed story. The Federal Reserve is likely to take more measured steps than it did last year. The central bank regularly increased rates by half a point or more for much of 2022, but it adopted a smaller quarter-point increase last month and is widely expected to repeat that step at its next meeting in May.
There is a risk that the Fed does too little and inflation persists, as happened in 2021. But there is also a risk that the Fed goes too far and does unnecessary damage to the economy, as this newsletter has explained before. A strong economy can lead to faster price increases. But a weak economy can put a lot of people out of work. Policymakers are trying to find a sweet spot between those two extremes.
The latest inflation data suggests that the country is getting there — that an end to rapidly rising prices is perhaps becoming visible now. But the data is not clear enough to rule out a mirage.
And, from the New York Times' Peter Coy: There are two rival explanations for why banks are doing less lending. The one you hear most is that there’s an emerging credit crunch: Banks are tightening their lending standards and turning people down for credit. That would be bad. The other possibility, though, which could be worse, is that the banks have money but people don’t want it.
Most likely, there’s some of each going on. First, take a look at the data. Loans and leases on the books of commercial banks in the United States jumped briefly early in the pandemic. But in the two weeks through March 29 of this year, the latest with available data from the Federal Reserve, loans and leases fell by $105 billion, or nearly 1 percent. That was the biggest two-week decline in dollar terms since the data series began in 1973 and the biggest in percentage terms since 2009, during the global financial crisis.
Banks have lost $590 billion in deposits since the end of January, a drop of more than 3 percent. Money that left the banks is going into money market mutual funds, which are stashing it at the Federal Reserve, a “financial black hole,” as far as lending is concerned, as Paul Ashworth of Capital Economics wrote in a client note that I cited on Monday.
“People are for the first time in some time using the ‘c’ words: credit crunch,” Anirban Basu, the chief economist at Associated Builders and Contractors, a trade association, told The Times in an article published Monday. The Federal Reserve Bank of New York’s Survey of Consumer Expectations found that the share of consumer respondents indicating that credit was harder to get than a year ago rose to 58.2 percent in March, the highest proportion recorded since the survey’s creation in 2013.
If you stop and think, though, a credit crunch, as bad as it is, at least indicates that there’s an appetite for borrowing that’s not being sated. When you really have to start worrying is when people don’t want to borrow because they see bad times ahead. In that situation, monetary policy becomes less effective; lowering the interest rate to induce borrowing is as useless as pushing on a string, as economists like to say.
Unfortunately, there are signs that the observable dip in loans and leases is at least partly due to weak demand. A New York Fed survey in February found that the application rate for any type of credit over the preceding 12 months declined to its lowest point since October 2020. It probably wasn’t because applicants fear being turned down. In fact, the reported overall rejection rate for credit applicants decreased to 17.3 percent from 18.8 percent in October 2022, the bank said.
That’s consumers. As for small businesses, which, unlike big companies, rely a lot on bank loans, only 2 percent of owners reported in March that all their borrowing needs were not satisfied, according to the National Federation of Independent Business; 29 percent of N.F.I.B. members who were randomly chosen for the monthly survey reported that all their credit needs were met, and 59 percent said they were not interested in a loan. Only 2 percent were planning an expansion, the least since March 2009. “That is a major ‘yikes!’” David Rosenberg, the president of Rosenberg Research & Associates, a forecaster, wrote to clients on Wednesday.
The Federal Reserve, determined to return inflation to its target of 2 percent annually, is putting a low priority on making more credit available to ease lending conditions. But even if it did change its stripes and chose to prioritize growth, it would have a hard time getting much done if the problem has become at least partly a lack of demand for loans.
Fiscal policy — government spending and tax cuts — is more effective in reviving weak demand. But since the start of 2021, fiscal policy has gone from stimulative to contractionary, according to a calculation by the Brookings Institution’s Hutchins Center. And Republicans in Congress are aiming to cut spending drastically, not raise it.
The bottom line is that a recession in the United States appears inevitable. It may already have begun, Julian Brigden, a founder and the president of the macroeconomic research firm Macro Intelligence 2 Partners, told me Tuesday. If not, the U.S. economy is likely to fall into recession in the third quarter of this year, he predicted. “This was essentially preordained” by the Fed’s large and rapid interest rate increases, he said.