By Paul Gomme and Peter Rupert
The Bureau of Economic Analysis has released Personal Consumption Expenditure data for May. On an annual basis, overall PCE inflation rose from 5.03% (April) to 5.53% (May). The year-over-year inflation rate also increased, from 3.80% to 4.07%. Our measure of trend PCE inflation is similarly up, from 5.29% to 5.37%. The Fed’s stated target is 2% inflation.
The Fed’s preferred measure, core PCE inflation shot up from 3.05% to 3.91% (month-over-month, annualized), or from 3.32% to 3.41% (year-over-year). Our measure of trend: 3.75%, up from 3.67%.
The new FOMC Chair, Kevin Warsh, has his job cut out for him. To be sure, after inflation rose in the post-pandemic environment, the Jerome Powell-led Fed failed to bring inflation down to its 2% target. Developments in the US-Iran war have, no doubt, contributed to the increase in overall PCE inflation. However, core PCE inflation — which strips out the “volatile” food and energy components — is far less susceptible to these developments.
To understand the problem facing Warsh, suppose that there are two types of central bankers: hawks who are tough on inflation, and doves who are not. It’s cheap for central bankers to go around telling everyone that they’re a hawk. Such speeches are largely uninformative. The implication is that when there is a change in leadership, the public is quite uncertain whether the new leader is a hawk or a dove. (We’re ignoring the unlikely case in which the central banker wants to be known as a dove.) How does a central banker gain a reputation for being a hawk? By making tough decisions that a dove would not. In the current environment, a dove would be prone to lowering the Fed funds rate; a hawk would raise it. Leaving the rate unchanged may well be interpreted as being dove-like. Importantly, once a central banker comes to be viewed as a dove, it is very difficult to rehabilitate that reputation: it would requite a prolonged period of hawk-like actions. Assuming that Warsh is committed to a 2% inflation target, he has a tough choice between: (a) immediately behaving like a hawk, raising the Fed funds rate; or (b) later acting like a hawk and for a much longer period of time. Acting later will be economically more disruptive than acting preemptively. Good luck Mr. Warsh.
