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Question #5 for 2022: Will the core inflation rate increase or decrease by December 2022?

by Calculated Risk on 1/02/2022 03:24:00 PM

Earlier I posted some questions on my blog: Ten Economic Questions for 2022. Some of these questions concern real estate (inventory, house prices, housing credit, housing starts, new home sales), and I posted those in the newsletter (others like GDP and employment will be on my blog).

I’m adding some thoughts, and maybe some predictions for each question.

5) Inflation: Core PCE was up 4.7% YoY through November. This was the highest YoY increase in core PCE since 1989. The FOMC is forecasting the YoY change in core PCE will be in the 2.5% to 3.0% range in Q4 2022. Will the core inflation rate increase or decrease by December 2022?

Although there are different measure for inflation, they all show inflation well above the Fed’s 2% inflation target.

Note: I follow several measures of inflation, median CPI and trimmed-mean CPI from the Cleveland Fed. Core PCE prices (monthly from the BEA) and core CPI (from the BLS).

Inflation MeasuresClick on graph for larger image.

This graph shows the year-over-year change for these four key measures of inflation. The recent spike in inflation is obvious – and will likely get worse over the next few months. Goldman Sachs economists recently wrote:

“The current inflation surge is likely to get worse before it gets better”
On a year-over-year basis, the median CPI rose 3.5%, the trimmed-mean CPI rose 4.6%, and the CPI less food and energy rose 4.9%, and Core PCE increased 4.7% year-over-year.
The key question is will inflation trend down towards the Fed’s target in 2022? The Fed is projecting core PCE inflation will decrease to 2.5% to 3.0% by Q4 2022.
On inflation Goldman Sachs is projecting a significant decline in inflation:

by the end of [2022] we expect core PCE inflation to fall to 2.5%. Admittedly, the key driver of our forecast–the partial resolution of supply-demand imbalances in the durable goods sector–is hard to time. But we do not see underlying wage growth or inflation expectations as inconsistent with the Fed’s 2% inflation goal, and therefore expect inflation to begin to come down meaningfully.
The pandemic was the cause of the inflation spike, with supply constraints, a shifting of demand from services to goods, large fiscal transfers, and a smaller labor force pushing up wages. If the pandemic eases, I expect these pressures to ease. My guess is core PCE inflation (year-over-year) will decrease in 2022 (from the current 4.7%), and I think core PCE inflation will be at or below 3% by the end of 2022.

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