快訊：抗通脹 - 最後階段

Originally published in Stephen Dover’s LinkedIn Newsletter Global Market Perspectives. Follow Stephen Dover on LinkedIn where he posts his thoughts and comments as well as his Global Market Perspectives newsletter.

In shipping, the “final mile” refers to the end delivery point. In climbing, it refers to the most arduous ascent to the peak. No matter the context, the final mile is the culmination of a worthy endeavor.

In the context of fighting inflation, the “final mile” represents the successful and sustainable achievement of a central bank’s inflation target. For the Federal Reserve (Fed), which began tightening monetary policy in 2022 when core personal consumption expenditures index inflation peaked at 5.8%, the final mile represents the challenge of bringing it down from its current rate of 3.7% to its 2% target.

As worthy as the objective is, the final mile can come at significant cost. At altitude, oxygen is depleted and muscles ache. In transportation, goods must be offloaded from larger to smaller trucks at considerable cost.

Is the same true for monetary policy? Is the final mile the costliest part of restoring price stability?

According to Fed Chairman Jerome Powell, the answer is most likely “yes.” If that is true, are markets prepared for the hardship? Based on current pricing in stocks, bonds and currencies, the answer is “probably not.”

How the Fed sees the final mile

Perhaps the biggest surprise in macroeconomics this year has been the resilience of the US economy and its labor market following aggressive Fed tightening since early 2022. Despite dire warnings from most economists, supported by classic “leading indicators” of recession—such as an inverted yield curve—the US economy has motored ahead. If anything, over the past two years growth has exceeded its trend. Job gains have exceeded the growth of the labor force,¹ resulting in five-decade low unemployment rates.

Falling inflation across all measures (core, headline, consumer prices and wages) has accompanied strong growth and a tight labor market. So why must the final mile—the achievement of the Fed’s 2% inflation target—be painful?

That is an important question. The Fed's consistent message over the past year has been that a fall in inflation to its target will require a period of below-trend growth. Put differently, the Fed believes that for inflation to sustainably complete its desired decline, some slack must emerge across the economy, and particularly in the labor market.

That notion hinges on an apparent empirical regularity first published in 1958 by the New Zealand economist William Phillips. The eponymous “Phillips Curve” purports to show a trade-off between inflation and the rate of unemployment. Specifically, inflation is high and rising when unemployment is very low, and inflation typically declines when unemployment is elevated.

The Fed’s Phillips fascination

Powell has clearly stated that some slack in the economy will probably be needed to achieve lasting low inflation. In his recent remarks before the Economic Club of New York, Chairman Powell noted:

Second, as noted above, Powell's statement seemingly dismisses the fact that US measures of core and headline inflation, as well as wage inflation, have all declined sharply over the past 12 months without a period of significant below-trend growth, much less a significant increase in unemployment.

So why is the Fed insistent that sustainably achieving its 2% inflation target will require below-trend growth and rising unemployment?

Several factors likely enter the Fed’s thinking.

• First, there is a widespread perception, to some extent backed up by recent data, that declines in inflation will slow or even stall before the 2% target is reached. One such area of concern today is stubborn core services inflation, excluding rents.
• Second, while wage inflation has slowed, its current pace of 4.4% (average hourly earnings) or 4.3% (Employment Cost Index basis) is considered above what is consistent with 2% core price inflation. For instance, if trend productivity growth averages 1% per annum (a reasonable estimate), then wage (and benefit) inflation would have to fall by a further percentage point for price stability to ensue.
• Third, as shown in Exhibit 2, below, there may be a Phillips Curve trade-off when the unemployment rate falls below 4.5%. That is shown in the diagram by the curved line of best fit. If so, then getting inflation down the final mile may require some rise in the unemployment rate from its current level (3.7%). Indeed, using regression techniques to measure the trade-off between unemployment and inflation when the unemployment rate is below 4.5% indicates that for every 0.1% increase in the unemployment rate, the year-over-year Consumer Price Index (CPI) core inflation rate falls by 0.3%.