Post-COVID Inflation Dynamics: Higher for Longer

Abstract

In the December 2022 Summary of Economic Projections (SEP), the median projection for four-quarter core PCE inflation in the fourth quarter of 2025 is 2.1 percent. This same SEP has unemployment rising by nine-tenths, to 4.6 percent, by the end of 2023. We assess the plausibility of this projection using a specific nonlinear model that embeds an empirically successful nonlinear Phillips curve specification into a structural model, identifying it via an underutilized data-dependent method. We model core PCE inflation using three components that align with those noted by Chair Powell in his December 14, 2022, press conference: housing, core goods, and core-services-less-housing. Our model projects that conditional on the SEP unemployment rate path and a rapid deceleration of core goods prices, core PCE inflation moderates to only 2.75 percent by the end of 2025: inflation will be higher for longer. A deep recession would be necessary to achieve the SEP’s projected inflation path. A simple reduced-form welfare analysis, which abstracts from any danger of inflation expectations becoming unanchored, suggests that such a recession would not be optimal.

Pandemic Paydays: Wage Gains and the Threat of Fiscal Tightening

“…29,30 A paper from the Federal Reserve Bank of Cleveland warned that bringing down inflation would be even more painful, pushing unemployment to double of what it is now. 31 Wages are being used as an indicator, if not a rationale, for running punishingly high interest rates, even while wage gains remain well below year-over-year changes in the consumer price index. (According to the Employment Cost Index, the amount employers spent on wages actually fell over the past year.)…”