Briar C. from Morgantown, WV asks: Hi Mitch, inflation is still a top issue in the U.S. economy today. Are there signs that prices are coming down anywhere? Or should we expect these higher prices to be the new normal? Thank you.
Mitch’s Response:
Thanks for sending your question, Briar. To answer your question, I think it’s important first to make a distinction between “disinflation” and “deflation,” which are two very different things.
Disinflation is what the Federal Reserve wants to see today, and it’s arguably what the economy needs to arrive in a ‘soft landing’/goldilocks state. By definition, disinflation means prices are still growing month-over-month and year-over-year, it’s just happening at a slower pace than previous months and years.1
In May, for instance, the U.S. Labor Department reported that CPI rose 3.3% year-over-year, an improvement from April’s 3.4% print. On a month-over-month basis, prices rose 0.2% in May, which was the lowest monthly reading since July 2023. That’s disinflation, and it’s what the Fed and the markets wanted to see following a hot Q1 2024 for prices.
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May’s CPI report also showed other signs of improvement in the inflation picture. The CPI report looks at dozens of different categories of spending and prices, and we saw the breadth of rising prices get narrower. Across the CPI, 47% of components were rising at a pace below 4% year-over-year, which was an improvement from 41% in April.
With this understanding of disinflation, the answer to the second part of your question is yes—you should expect prices at current levels to be the ‘new normal.’ Prices across the economy have reset to higher levels, and in the future, we want to see prices continue moving higher, albeit at a modest 2% to 3% annual pace. Modest inflation can be viewed as good for the economy, as it promotes spending growth, wage growth, and investment.
Deflation, on the other hand, is very different. That’s when prices are falling from period to period, which can be a sign of trouble in the economy. If consumers expect prices to come down in the future, they may choose to spend less today—which means sapping the main engine of the U.S. economy. If consumers are spending less, corporations may respond by slowing production, laying off workers, investing less, reducing wages, etc. That’s not what we want to see.
There were signs of deflation in the latest CPI report, with the “supercore services index”—which excludes shelter prices—falling slightly from April. This was the first time that’s occurred in over two years. This is just one data point, however, and there are few signs that deflation is taking hold anywhere.
On a high level, I think we’re getting closer and closer to a time when inflation settles back near the Fed’s target, which again means that prices will keep rising from where they are now—just at a slower overall pace.
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