November 27, 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 0.2% in October after climbing 0.2% in September. The year-over-year increase now stands at 2.3%.

Excluding the volatile food and energy components the PCE deflator rose 0.3% in both September and October  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%.   We believe inflation will continue to slow gradually, but will stay above target until late in 2025.

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  $0.5 trillion.  If the Fed keeps shrinking the money supply at its current pace, this surplus liquidity should be eliminated by the early part of next year which should allow the core inflation rate to continue to fall slowly.

We expect the core PCE deflator to climb 2.9% in 2024. The funds rate is currently 4.8%. The core PCE deflator today is 2.9%,.  This means that the inflation-adjusted or real funds rate today is +1.9% .  That seems to be a bit on the high side (the Fed thinks a neutral real funds rate is +0.9%).  If the inflation rate edges its way lower to 2.3% by the end of next year, the Fed should be able to lower the funds rate to about 3.3%.

GDP grew 2,8% in the third quarter.  We expect to see GDP growth of 2.5% in the fourth quarter.

Stephen Slifer

NumberNomics

Charleston, SC