February 29, 2024

There are many different measures of inflation, but the one that the Federal Reserve considers to be most important is the personal consumption expenditures deflator, in particular the PCE deflator excluding the volatile food and energy components.

The PCE deflator rose 0.3% in January after having risen 0.1% in December. The year-over-year increase now stands at 2.4%.

Excluding the volatile food and energy components the PCE deflator 0.4% in January after having gained 0.1% in December.  The year-over-year increase is now 2.8%.  This is the inflation measure that the Fed would like to see rise by 2.0%.   It raised rates steadily throughout 2023 in an effort to reduce the rate of inflation and it has been quite successful.  We believe inflation will continue to slow gradually, but will stay above target for some time to come.

The  purchases of Treasury securities by the Fed in 2020 and 2021 caused money supply growth to surge.  We all learned back in our basic economic classes that money growth is the cause of inflation.  However, the length of time between a pickup in money growth and an increase in inflation is both long and variable.  Thus, the earlier increase in  money growth caused the inflation rate to climb well above the Fed’s 2.0% target for a protracted period of time.  However, as the Fed has been running off some of its holdings of U.S. Treasury and mortgage backed securities, the money supply has declined in recent months.  The problem is that the earlier rapid growth pushed the level of M-2 far higher than its trend path would suggest.  At its peak that difference was $4.0 trillion which represented surplus liquidity in the economy.  At the moment that difference is  $0.9 trillion.  That surplus liquidity will make it difficult for the core inflation rate to continue falling quickly.  If the Fed keeps shrinking the money supply at its current pace, this surplus liquidity should be eliminated by the spring at which time we should expect the core inflation rate to continue to fall slowly.

After rising 2.9% in 2023 we expect the core PCE deflator to climb 2.6% in 2024. The funds rate is currently 5.5%. The core PCE deflator today is 2.8%,.  This means that the inflation-adjusted or real funds rate today is +2.7% .  This is finally getting high enough to slow the pace of economic activity and significantly reduce the inflation rate.

We expect GDP growth of about 2.0% in first half of this year.

Stephen Slifer

NumberNomics

Charleston, SC