The insightful lyrics of Tom Petty’s 1981 hit song “The Waiting” focus on how waiting can be difficult and uncertain. That’s why I quoted them in the November 2017 Monthly Economic Review, when the economy was growing at 3% year over year, unemployment was at its lowest level in 17 years, and we were waiting to see when tightness in the labor market would translate into higher wages and inevitable inflation.
Today, we’re waiting once again. Much like 2017, the economy is going strong and the labor market is still relatively tight. But this time we’re waiting for inflation to come down — and also waiting for the Federal Reserve to decide on when to lower interest rates. Just as the song talks about the challenges of waiting, we’re at a critical moment as consumers, businesses, investors and others wait to learn how they will need to adjust their plans for future economic conditions. It’s a time of uncertainty, reminding us that former Fed Chairman Alan Greenspan once said uncertainty is not just a feature of monetary policy but the determining characteristic.
Unfortunately, no one ever knows with any certainty how fast the economy can grow without generating inflation or impacting inflation expectations. The challenge is that no one can forecast inflation, its momentum or the likely intersection of monetary policy and the economy with much accuracy. When measuring inflation, whose inflation matters — different people and businesses are impacted by inflation in different sectors of the economy — and how it is measured is open to research and analysis. This uncertainty is always an intricate and difficult problem for the Fed. If the Fed keeps the level of interest rates too high, it could slow the economy to the point of recession, causing household and business spending to plummet. Alternatively, if it lowers interest rates too much, it could overstimulate the economy and stoke inflation. We can send someone to the moon, but forecasting the economy remains a challenge due to the dynamic nature of economic factors and the unpredictability of human behavior.
Fortunately, the risks for monetary policy look balanced at the moment.
It is the general consensus of economists and policymakers that the U.S. economy and labor markets have continued to expand in a healthy fashion even though they are doing so with slower momentum. This conforms with the latest gross domestic product data, which shows the economy grew at a 1.4% annual pace in the first quarter. That was down from 3.4% in the fourth quarter of 2023 and was the slowest quarterly growth since the spring of 2022. A key contributor to the deceleration was slower consumer activity. One measure of inflation, the GDP Price Index, was at an annualized rate of 3.1% during the first quarter while the Personal Consumption Expenditures Price Index — the Fed’s preferred inflation barometer — was at 3.4%.
The Fed likely welcomed data that showed household income, spending and saving were all healthy in May, demonstrating that the economy is growing at a slower-but-steady pace. Unadjusted for inflation, disposable personal income (income after taxes) rose 0.5% month over month in May and was up 3.7% year over year. Personal consumption rose 0.2% monthly and was up 5.1% compared with a year earlier. The savings rate rose to 3.9%, the highest in four months. Other data indicates that price pressures are easing. Year-over-year, the PCE index was up 2.6% in May. Over the same period, prices for goods decreased 0.1%, even though prices for services prices rose 3.9%. Food prices were up 1.2% and energy prices were up 4.8%.
Meanwhile the labor market continues to display resilience and has propelled income growth ahead of inflation. Employment growth rebounded strongly with a gain of 272,000 jobs in May after an increase of 165,000 in April. Average monthly employment gains through May were 248,000, only a touch behind the 2023 average of 251,000.
According to the University of Michigan’s June Consumer Sentiment Survey, consumers exhibited confidence that inflation will continue to moderate, but many expressed concerns about the effect of high prices and weakening income on their personal finances. Federal Reserve Board of Governors member Lisa Cook recently said current policy is putting downward pressure on demand, pointing to high mortgage rates and rising debt delinquency rates, which she said "are not yet concerning for the overall economy but bear watching." Many studies have reported that lower-income consumers are facing significant challenges, impacted by the high level of food, housing and transportation prices. Many consumer companies have noted weakness in spending given the cumulative impact of years of inflation on this demographic. It is uncertain whether economic stress among lower-income families could become larger and derail the current economic expansion.
The U.S. economy looks resilient enough for the Fed to wait and has afforded the Fed time to do so at this key time. The Fed left interest rates unchanged in June and predicted the rate will change just once before the end of 2024. Chairman Jerome Powell said officials were taking a careful and conservative approach. I wonder if he is singing Petty’s refrain — “You take it on faith, you take it to the heart, the waiting is the hardest part.”