MNI INTERVIEW:Fed Awaits Inflation Peak For Next Moves-Garriga

The beginning of peak pandemic-era inflation is likely to arrive in the first half of 2023, while five or six months of data on falling inflation are needed before the Fed can say with any certainty how quickly price growth will moderate, St. Louis Fed research director Carlos Garriga told MNI.

"We want to have not just a turning point but solid declines in inflation to start thinking about making adjustments to the policy, and Chair Powell has said that consistently," he said in an interview. "Right now we have not even changed the trend from increasing to flat or decreasing to assess which way things will decline in 2023."

With wage pressures pushing up the price of services and rising housing costs hitting CPI with a lag, inflation is likely to remain elevated through the end of the year, Garriga said. Former Fed officials told MNI this week rates are likely to top 5% next year after CPI rose 8.2% in the year to September and core CPI accelerated to a new 40-year high of 6.6%.

"There are multiple components that may feed into inflation outcomes in the next few months before potential for further progress I suspect in 2023," Garriga said. "It’ll be obvious to everyone when we are in a flat period in which inflation has plateaued."

RISK MANAGEMENT

The speed of disinflation matters for Fed policymakers who have espoused a risk management approach to curbing inflation. Interest rates need to stay restrictive for longer if inflation proves more stubborn than expected, because the risk of allowing inflation to get out of control outweighs the risk of overtightening.

"As has been said by the chair and others, it's better to err on the cautious side and be aggressive with inflation," Garriga said.

The challenge is predicting the speed of disinflation. Traditional economic models have not grappled with rapid increases in inflation in decades, let alone rapid disinflation, though history suggests some potential paths. Hyperinflation came to a sudden end after the two world wars following credible adjustments by both fiscal and monetary authorities, as economist Tom Sargent has documented.

"Covid is akin to a health war fought by many countries," Garriga said. "If the analogy works, we could expect a disinflationary period in 2023 and 2024, and it could be fairly quick as we saw in these earlier episodes."

SOFT LANDING

Most economic forecasts are based on the premise that there are no additional shocks in the next 15 months. If that's the case, a path to a soft landing remains possible based on strength seen in the labor market thus far, Garriga said.

"We don’t see a wage-price spiral in the data right now. We do have a tight labor market but we expect the adjustment will be a reduction in vacancies and in job-to-job transitions versus a movement from employment to unemployment (as rates rise)."

Businesses in the St. Louis Fed region also report supply-side constraints are improving rapidly. "Some costs are going down. The labor situation hasn't improved, but we've been hearing firms are finally making the appropriate adjustment, understanding that they may not fully staffed."

But Garriga cautioned against holding onto certainty. The world was dominated by disinflationary forces for decades before the pandemic. Now shocks related to the pandemic, the reopening, the energy crisis, China shutdowns and a potential global recession are driving the economy.

"A risk management approach would be to expect the unexpected," he said.