Inflation is easing even as the labor market remains strong
Inflation and all of its main drivers sharply decelerated in the last half of 2022. This was the case even though the pace of economic growth accelerated in the second half of the year and unemployment remained very low.
The Federal Reserve’s “dual mandate” is meant to balance the risks of inflation versus the benefits of fast growth and low unemployment. Right now, the benefits of low unemployment are enormous, and the risks of inflation are retreating rapidly. If the Fed lets the current recovery continue apace by not raising interest rates further at this week’s meeting, 2023 could turn out to be a great year for the economic fortunes of American families.
It is time for the Fed to stand pat on interest rate increases and wait to see how the lagged effects of past increases enacted in 2022 will filter through to the economy. Continuing to raise rates in the early stretches of 2023 will be a clear mistake and pose an unneeded threat to growth in the next year. In particular, the Fed should note the following:
- Rapidly decelerating inflation in the last quarter of 2022 happened even in the absence of a strong disinflationary effect everybody knows is coming quickly in 2023: falling housing cost inflation.
- Wage growth is normalizing quickly—average wage growth for the last three months of 2022 relative to the previous three months was just 4.3% at an annualized rate. This is down from a peak growth rate of 6.1% seen earlier in 2022.
- Crucially, this proves that wage growth can normalize without a steep rise in unemployment. This should settle one of the key debates over monetary policy going forward.
- Corporate profit margins—one of the key drivers of inflation—will likely stabilize or even contract in the coming year. This means labor’s share of income will rise, which has the potential to absorb any wage growth that exceeds its long-run targets for years to come. Past experience suggests strongly that this is not just a vague hope, but will actually happen
