Inflation is falling from its peak of 9.1%. The most recent CPI reading was 5% compared to levels from a year ago. February’s increase was 6% (year on year) compared to January. Lower, but well above the Federal Reserve’s 2% target. The Fed raised its policy rate by 475 basis points (4.75 percentage points) to curb inflation (slow down the economy). Construction and housing, the usual casualties of monetary policy, have certainly slowed, but consumers and other businesses have been slower to react.
On Main Street, owners have clearly reduced their price increases, and the percentage planning to raise prices in the coming months has declined, both good news for the prospect of further inflation cuts. That is reinforced by the rising percentage reporting that they are lowering prices, not just sticking to the prices they are currently charging. Stopping inflation alone will not restore the purchasing power that inflation has destroyed since 2020. Indeed, the Fed’s commitment to 2% inflation is driving a sustained decline in the value of a dollar. To move forward in real terms, income needs to grow faster than 2%. A period of price cuts (typical in recessions) could restore lost purchasing power and undo inflationary damage, if widespread enough.
Over the past 49 years, NFIB survey data has anticipated the inflation path, underestimating it in 1980 and overestimating it in 2022-2023, but correctly anticipating major shifts. The regression analysis in Chart 2 illustrates the NFIB survey’s forecast in the first month of a quarter for inflation occurring throughout the quarter (announced weeks after the end of the quarter). Currently, the inflation trend is expected to slow down.
Most economic watchers see the economy weakening towards the end of the year. Weaker spending reduces the incentive and ability to raise prices, slowing the rate of price increases and inflation. A significant slowdown will lead to widespread price reductions, not just stabilization of prices at current levels. Deflation would begin to restore the lost purchasing power that resulted from rising prices. In some sectors where supply is artificially constrained (energy regulations, avian flu for eggs, etc.), prices will be less responsive to a general drop in demand, so the intensity of price cuts will vary from industry to industry. Policies that increase supply (eg more oil and gas) will lower prices. If inflation measures continue to weaken, the Fed will likely pause to assess the cumulative impact of its policies. Because much of GDP is sold on Main Street, the NFIB’s monthly indicators will provide clear signals about the direction of inflation.