The Daily - Inflation Is Way Down. Is It by Design or Just Luck?

Episode Date: June 20, 2023

Rapid inflation has been a problem in the United States for more than two years, but the tide appears to be turning. Annual inflation is now less than half of what it was last summer.Jeanna Smialek, who covers the Federal Reserve and the U.S. economy for The Times, discusses whether the decline is a result of careful policymaking, or more of a lucky accident.Guest: Jeanna Smialek, a Federal Reserve correspondent for The New York Times.Background reading: Inflation is coming down. Is the Fed winning its fight?How to read the Fed’s projections like a pro.For more information on today’s episode, visit nytimes.com/thedaily. Transcripts of each episode will be made available by the next workday.

From New York Times, I'm Michael Barbaro. This is The Daily. Today, after two years of record high consumer prices, inflation is falling in a big way. The question now being asked by economists, according to my colleague Gina Smilick, is whether that's by design or by accident. It's Tuesday, June 20th.

Good morning, everyone. This is a big day. New inflation numbers and, yeah, your money's at stake. New economic numbers showing inflation is easing up. 4% inflation at the consumer level. Much slower than the 9% that we had seen in the summer of last year. We know the goal is down. How down is this?

This is down. This is the slowest pace in two years. We're getting there just very slowly. Fed meets tomorrow. Big decision coming. In light of how far we've come in tightening policy, today we decided to leave our policy interest rate unchanged. The Federal Reserve hit the pause button today on hiking interest rates as it tries to tame inflation. hit the pause button today on hiking interest rates as it tries to tame inflation. That is a significant shift after 10 straight meetings where they raised interest rates. This is a really important moment for the economy and for the Federal Reserve.

It has been on this mission where it's... Gina, good morning. Good morning. Good morning. We wanted to talk to you as our resident inflation expert because it now feels that the U.S. government's long-term plan to try to lower inflation by raising the interest rate month after month after month is working. And it feels that way for two reasons. The first is that a few days ago we got data showing that monthly inflation is now less than half of what it was last summer. It's a really big decline. And right on cue, a day later, the Federal Reserve decided to pause its program of raising interest rates, which seemed to confirm the idea that inflation is in retreat. And so we come to you, Gina, to ask, are we correct to understand

that the government's policies are slaying the inflationary beast? So I can totally see why you would think that, because inflation has fallen quite a bit, and that is obviously really good news. Right. But I think the key question here and the question you're asking is whether policy is responsible. And the answer to that one is pretty complicated right now. The way I like to think about this is that we're really in a story where we're talking about luck on one hand and policy on the other. Okay. That's a great sounding framework, look versus policy. Explain it.

It means basically what it sounds like. Some of the decline in inflation that we're seeing is a result of policy from the Federal Reserve. But a lot of it is luck, which is to say that raising interest rates had little or nothing to do with it. Okay, give us an example of luck-based inflation decline? So I think that there are really two big areas that have experienced significant declines in inflation that had to do with luck or the way the world was expected to play out rather than purely sort of the policy response to inflation.

Gas and groceries. Two very big categories of expense in life. Exactly. And so I think gas is a good place to start. It really started to jump over the last couple of summers. And you probably remember, you know, when a gallon of gas costs something like $5 just for regular at the pump. I very, very well remember it because it turns into like a $70 tank of gas. Exactly. It was really painful for consumers. And that's come down by a lot. It's now like $3.59 a gallon. Similarly, for groceries, you probably remember that eggs, for instance, four or five months ago were something like $5 a dozen. And they're now down quite a bit to something more like $2.50. Right. 50% decline.

Very meaningful. Exactly. And so those are big declines, but they aren't necessarily categories that are sort of rooted in the Fed's policy response. Really, what we're seeing here is the sort of result of some big outside events. the sort of result of some big outside events. Why don't you start with gas? I mean, why is the decline in gas pretty much unrelated to federal policy and much more in the realm of luck? Right. So just in general, changes in oil and gas prices are almost always the result of sort of big global trends.

Decisions made by Russia, decisions made by Saudi Arabia, the speed of growth in other big economies like China. And so those things sort of move the price of gas around. You can get some domestic policies, like some things the White House can do can matter to oil prices around the edges. But mostly this is sort of this big external force acting on the economy. Got it. So not really because of federal policy? Not primarily.

Okay. And what about the big declines in grocery prices? Why do we not attribute that to rising interest rates? So I think we can start with egg prices, which we've previously talked about. So we obviously know that egg prices sp which we've previously talked about. So we obviously know that egg prices spiked really high earlier this year in January. They hit that $5 mark almost. And that was really about bad luck. We had a really bad bout of avian flu that was killing millions of chickens. And so chicken prices jumped, egg prices jumped. But more recently, that's really started

to clear up, which has been good luck. And so it's helped to bring prices down. And this is sort of what you see with food overall. By and large, when we think about things like food prices, we often think that they are pretty sensitive to big movements in commodity prices, in grain prices, in dairy prices. And so they're just not good as a clear read on where the economy is headed or how policy is working. Right, because the Fed does not eradicate avian flu. It does not spare the lives of chickens. So this is not a good measure of policy working. Like you said, it's a measure of kind of agrarian luck. Exactly. You're not going to get a clean assessment off of food prices. So very interestingly, Gina, the decline of inflation in these two big areas where higher

prices most directly impact us as consumers, it's not primarily because our central bank worked its magic, but the overall impact is that inflation is really down. Yes, inflation is really down. And another reason that overall inflation is down so much Yes, inflation is really down. And another reason that overall inflation is down so much is because we've really seen a lot of healing in supply chains, which, as listeners probably remember, got really messed up during and after the coronavirus pandemic, and which have been slowly getting back to normal. So the part of inflation we're worried about now is the part that's not going to come down just because

of a return to normal or because of luck, but the part that is going to require Fed policy. And we're seeing Fed policies start to work in some categories, but in many categories, we're not seeing that much progress yet. We're seeing this sort of split screen story in the economy where it is certainly the case that some big areas of inflation are moderating. But at the same time, we've got some other big areas that haven't budged very much. And that's why despite inflation cooling down so much

over the past few months, we still can't say that we've slayed the inflationary beast. We'll be right back. Gina, right before the break, you said that there are areas where the Federal Reserve's policy is starting to do what it's supposed to do, which is lower inflation, despite the fact that in a lot of areas,

it can't quite make that happen. So I want to zero in on the areas where Fed policy is working. So what's an example of that? So the one I would come back to most often, I think, is rents. So there was a while back in really the summer of 21 and into the spring of 2022 where rent increases were just crazy. If you live in New York, you probably remember, you know, rent was going up so fast. This was like brunch conversation. The rents were so quick. Right. This is like the story of the $6,000 one bedrooms.

Yeah, exactly. And that was really, really bad news on the inflation front because rents make up just a huge chunk of the inflation calculation. The good news here is that rents have really slowed down in the market. slowed down in the market. So what we're seeing is that sort of real-time data providers are telling us that for basically the past year, rents have been much slower to rise. And so that should really help to allow overall inflation to cool. And that is probably a little bit of a Fed story. Why? How do we know that? So one of the big ways in which rents are a Fed story is that they very closely track what's happening in the labor market and how confident people are feeling. So if you're making better wages, if you're feeling confident you're going to get that new job and you're going to get a raise because everyone loves you at work, you're going to feel much more comfortable springing for

that jacuzzi bathtub and taking on the slightly higher rent that comes alongside it. And so rents can be in a way a sort of economic sentiment indicator, or at least they're very closely connected. And so I think that if you want to point to a clear place where Fed policy is working, that's probably it. So just to be sure I understand this, Gina, when interest rates go up, as they have now for many, many months, the economy starts to look a little bit less rosy to a typical worker.

And you start to wonder if your economic prospects are going to be as strong as they once looked. And maybe you think twice about a long-term rental commitment, you know, a year or two years, that feels like a splurge. And so in that way, Fed policy, raising interest rates, helps lower the rental price increases that we have been seeing for so many months. Exactly. So when interest rates go up, the labor market slows down a lot. And economists will often tell you that the labor market and rents are very closely related. If your wages are going up, you feel more comfortable paying more. If your wages are stalling out, or you're even worried that you might get laid off,

you're going to feel much less comfortable paying more and your landlord just isn't going to be able to put up prices as much. And so rents can be a good barometer of where the overall economy is heading. Okay, so that's rent. I'm curious if this phenomenon you're describing is also translating over to housing sales, not rent,

but people purchasing homes, a really big important part of the economy where Fed policy in theory could have this desired impact of slowing things down. So yes, but housing is a pretty weird situation right now. Higher interest rates absolutely did cool off the housing market last year, and sales are still pretty depressed. But what we're seeing is that there's some demand out there sort of lingering on the sidelines, and there's not a lot of supply in the housing market. So while home prices actually fell late last year, they've recently started to turn around and climb again. And so I think the upshot here is that the Fed did cool housing, but it hasn't exactly kept it in a deep freeze.

Okay. And it sounds like you're saying they would like for it to be in something resembling a deep freeze. Yeah. I think that a deep freeze would give them confidence that they have cooled off the economy in this way that's being sustained. And instead, what we're seeing is that the economy still has some oomph, despite everything that the Fed has done. And it's one of the reasons that in some pretty important categories, you really just haven't seen price increases come down that much. Right, because oomph is another word for prices that are a little bit higher than we'd like. Yeah, if you have stronger demand, if you have that little bit of consumer oomph,

it allows companies to keep raising their prices. I could just keep saying oomph all day long. But can you tell us where in the economy the prices remain stubbornly high and where as a result, we can understand the Fed policy to have been stymied? Yeah, so one word here, services. And by that I mean stuff like child care,

concert tickets, haircuts, you know, anything that you buy that's a non-physical good, that really is sort of very labor-based. That's sort of the area we're worried about right now. And what's our understanding of why those categories, which like groceries and like gas, are a pretty big part of your life, right? Like, why are these categories so difficult

for the Fed's policy to pierce and to bring prices down on? So it's a couple of things simultaneously. One is that wage growth remains relatively quick. And that matters in two ways. It matters first because if, as a company, you are paying more, you are likely going to try and pass along those higher costs to your consumers in the form of higher prices. American shopper, you are earning more in wages, you are likely going to be able to turn around and spend a little bit more, even if you're not thrilled about it, when the company that you're buying stuff from is trying to charge you. And so it helps to keep prices climbing. The other thing is that corporations have gotten pretty used to charging more. And so we're seeing a situation where they know they have a little bit of ability to push up prices, and they're doing that either to maintain or to grow their profits. These are sort of a bunch of trends that, you know, you and I, Michael, and you and other guests have talked about in the past.

But what's surprising is that they remain true even in spite of everything the Fed has done to cool down the economy. Fascinating. Gina, I'm curious about something. down the economy. Fascinating. Gina, I'm curious about something. If rent increases go down because workers slash consumers start to psychologically feel things are a little more delicate, how does that square with what you just said that workers slash consumers are feeling good enough that they're willing to pay for higher prices on things like concert tickets and haircuts. How do we make sense of that? Well, if you think about it, you know, a rental agreement is really sort of a bet on the future. You're entering into a 12-month or 24-month agreement and you're saying

you're going to pay this amount for that entire period. And so you have to assess whether you're going to be able to do that. Whereas, you know, a haircut or a concert ticket, you know, something that is a little bit more in the moment is really a reflection of how you're feeling about your finances just today, not looking forward to the future. And so they don't have sort of that barometer of how you're feeling about your prospects embedded in them. Another thing we probably want to think about with rents is that you've got a certain population that's renting. And they're the people who are likely getting squeezed pretty severely by inflation right now.

It is the case that renters tend to skew a little bit younger. They tend to skew a little bit lower income. And so we could see sort of a divided situation in the economy where those folks are really struggling to sustain their spending at a comfortable level and struggling to pay up more to rent the place that they want to rent. Whereas we've got people who own their houses who are a little bit more financially well off, who are a little bit older, and they're still really able to consume like crazy. So Gina, if you're the central bank, if you're the Fed, you're probably pretty frustrated that you can't knock some of these stubborn price increases that we've been talking about down after all these months of raising interest rates, which is supposed to make

borrowing more expensive, as we talked about, which is supposed to cool down the economy and ultimately bring down prices. And so that makes me wonder why the Federal Reserve didn't use its power to keep trying to lower inflation last week when it had the chance. It could have come out and said, listen, America, we still have work to do here on inflation. And so we're going to have to raise interest rates. We just haven't gotten as far as we'd like to. And instead, the Fed didn't do anything, which is a little bit counterintuitive given everything you've told us here. So why didn't the Fed just raise interest rates another time? Right. So a couple of things here. So the Fed did not raise interest rates,

but it's not exactly the case that they didn't do anything. What the Fed did is it hit pause on interest rate increases for the first time in 11 meetings. Very big deal. But it also signaled that it's going to raise rates twice more this year, which is more than we had expected. And so that was a bit of a surprise. And I think that the message it sent was, we want to be cautious here. We want to try not to blow up the economy, but we're pretty darn worried about where

inflation is headed. And the reason I think that the Fed decided to hit pause now and promise to do more or suggest that they might do more later is that we've been pretty worried about banking turmoil recently. The Fed had suggested that it might sort of take a pause, look around, try and assess how the moves it's already made were playing out after we saw a bunch of banks blow up amid rising interest rates. And so I think that that was part of the reason for the caution. And I think part of the reason for the caution is just the Fed has done a lot already. And so it kind of wants to slow walk this to try and make sure that they sort of nail the landing here, that they do enough to get inflation under control,

but not so much that they absolutely tank the economy in the process. Right. In other words, this was not a pause in raising interest rates that said, hey, we're in great shape. We've turned a corner. This was a pause that said, let's make sure that we still have a banking sector in a year or so. And oh, by the way, inflation is actually still a problem and we are going to raise interest rates, just not this very moment. Exactly. The Fed was not declaring victory here. So in conclusion, here's where we are. Inflation is down overall quite a bit, but we've learned that a lot of it, the stuff we feel the most, isn't truly the result of Fed policy, which is an important thing to understand. But, Gina, if I'm a consumer,

how much do I really care about what caused this relatively positive situation? Inflation now down by half since last summer. Grocery store shopping doesn't suck as much as it used to. Traveling by car financially is much more tolerable. Aren't I just pretty happy that all of this stuff has happened? Sure, and reasonably you would be. But if you're a consumer, you also don't want this to be temporary. And 4% inflation is better than 9%, but it's still not as good as 2%, which is what it used to be.

So I think that, you know, that's the thing to keep in mind. Gas prices are down right now, but the Fed can't control them and they might rise again. And the same thing could be said for many parts of the economy that the Fed can only control somewhat. And so that is why the Fed is so focused on wrestling inflation the whole way back down to its very low and stable goal and keeping it there in sort of a much more sustainable way. You want to know that policy is working and working in a way that you intend. And we just aren't quite there yet. Right. You really don't want to live in a world, you're saying,

where your inflation goes down because of luck. You want it to sustainably go down because of policy so that it truly stays down. Yeah. Luck can be good or bad. Policy is much more deliberate. Well, Gina, thank you very much. We appreciate it. Thank you for having me. We'll be right back. Here's what else you need to know today. Here's what else you need to know today.

The Times reports growing evidence suggests that it was Russia that destroyed a major dam in Ukraine, an act that has displaced thousands of local residents and endangered vital farmland that supplies food to much of Europe. Both Russia and Ukraine have blamed the other for sabotaging the dam, which held back one of the world's largest reservoirs. But the Times spoke to engineers who said that the most likely cause was an explosive charge placed in a concrete passageway deep inside the dam. Such an attack would have been easy for Russia to carry out because it controlled the dam when it was destroyed. And over the weekend, two former members of Donald Trump's presidential cabinet

denounced his handling of classified documents and suggested that the evidence contained in the special counsel's indictment against Trump should disqualify him from ever being president again. One of them, Trump's former defense secretary, Mark Esper, called the behavior alleged in the indictment, quote, unauthorized, illegal, and dangerous. Do you think Trump can be trusted with the nation's secrets ever again? Well, based on his actions, if proven true under the indictment by the special counsel, no. I mean, it's just irresponsible action that places our service members at risk,

places our nation's security at risk. The other, Trump's former attorney general, Bill Barr, described Trump's conduct in the case as, quote, reckless and called him a, quote, fundamentally flawed person. He's like, you know, he's like a nine-year-old, a defiant nine-year-old kid who's always pushing the glass

toward the edge of the table, defying his parents to stop him from doing it. It's a means of self-assertion and exerting his dominance over other people. And he's a very petty individual who will always put his interests

ahead of the country's. But our country can't be a therapy session for, you know, a troubled man like this. Today's episode was produced by Rochelle Banja, Will Reed, and Rob Zipko. It was edited by Lisa Chow and M.J. Davis-Lynn, contains original music by Dan Powell and Marion Lozano and was engineered by Chris Wood. Our theme music is by Jim Brunberg and Ben Landsberg of Wonderly. That's it for The Daily.

I'm Michael Barbaro. See you tomorrow.