Inflation
Inflation
A Framework for Monitoring and Independent Assessment
Introduction
Inflation, the persistent rise in the general price level of goods and services, erodes purchasing power and poses a constant challenge for economic stability. Central banks, including the Federal Reserve, actively monitor and manage inflation to ensure smooth economic functioning, striving to avoid both excessive inflation and deflation.
To learn more about the Federal Reserve’s dual mandate and its implications for monetary policy, refer to our research on monetary Policy.
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Monetary Policy CycleThe Federal Reserve’s dual mandate, established by the Federal Reserve Act of 1977, charges the Fed with promoting maximum employment and stable prices. The Fed interprets stable prices as a 2% inflation target, as measured by the PCE index. The Fed’s policy decisions hinge on achieving this target, with the goal of maintaining price stability and fostering economic growth.
The 2% percent target
The Federal Reserve aims to maintain inflation at a 2% target rate, as measured by the Personal Consumption Expenditures (PCE) index. This target reflects the Fed’s commitment to price stability and economic growth, providing a benchmark for policy decisions. The 2% target is not a strict ceiling but a flexible goal, allowing the Fed to adjust policy in response to economic conditions.
Understanding inflation requires recognizing its different facets. Headline inflation, a widely cited figure, reflects overall price changes across the economy, including volatile food and energy prices. Core inflation, on the other hand, strips out these volatile components to reveal underlying trends. While headline inflation captures the immediate impact on consumers and businesses, the Fed focuses on core inflation for its stability and relevance to long-term policy decisions.
Several key metrics track inflation’s trajectory:
- The Consumer Price Index (CPI): The CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The Bureau of Labor Statistics (BLS) releases the CPI monthly, providing a snapshot of inflationary trends.
- Producer Price Index (PPI): PPI provide snapshots of price changes at the consumer and producer levels, respectively.
- Federal Reserve favors the Personal Consumption Expenditures (PCE) index: PCE is a broader and more flexible measure that captures a wider range of household spending.
- Trimmed Median PCE: The Trimmed Median PCE excludes the most extreme price changes, providing a more stable measure of inflation.
Objective
This report analyzes current inflation trends through the lens of the Federal Reserve’s dual mandate, aiming to decipher the Fed’s stance on inflation and anticipate potential policy actions.
By examining the specific inflation measures the Fed prioritizes, dissecting their communications, and delving into the economic data they scrutinize, we seek to understand the factors shaping their policy decisions. This analysis will empower readers to form their own independent judgments about the path of inflation and the likely course of monetary policy.
Main Indicators of Inflation
Headline Inflation
When you think about inflation, most likely you are thinking about headline inflation. Headline inflation is the measure of the total inflation within an economy, including commodities such as food and energy. The Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) index are the most commonly used measures of headline inflation. PCE inflation is the preferred measure of inflation by the Federal Reserve.
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Headline PCE | -- | -- | 2.54 | 2.52 | 2.6 | 2.46 | 2.34 | 2.1 | 2.28 | 2.47 | 2.44 | 2.57 |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Δ Change PCE | -- | -- | 0.02 | -0.09 | 0.15 | 0.12 | 0.24 | -0.18 | -0.19 | 0.03 | -0.13 | -0.15 |
| Trend in PCE | -- | -- | Up | Up | Up | Down | Down | Down | Down | Down | Down | Down |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Headline CPI | -- | -- | 2.82 | 3 | 2.89 | 2.75 | 2.6 | 2.44 | 2.53 | 2.89 | 2.97 | 3.27 |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Δ Change CPI | -- | -- | -0.18 | 0.11 | 0.14 | 0.15 | 0.16 | -0.09 | -0.36 | -0.08 | -0.3 | -0.09 |
| Trend in CPI | -- | -- | Down | Up | Down | Down | Down | Down | Down | Down | Down | Down |
Core Inflation
Core inflation, a measure that excludes volatile food and energy prices, provides a more stable and reliable gauge of underlying inflationary trends.The Federal Reserve focuses on core inflation to make informed policy decisions, as it better reflects the economy’s long-term trajectory.
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Core PCE | -- | -- | 2.79 | 2.66 | 2.86 | 2.83 | 2.82 | 2.66 | 2.73 | 2.67 | 2.63 | 2.67 |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Δ Change Core PCE | -- | -- | 0.13 | -0.2 | 0.03 | 0.01 | 0.16 | -0.07 | 0.07 | 0.03 | -0.04 | -0.22 |
| Trend in Core PCE | -- | -- | Up | Down | Up | Up | Down | Down | Down | Down | Down | Down |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Core CPI | -- | -- | 3.14 | 3.29 | 3.21 | 3.28 | 3.29 | 3.29 | 3.29 | 3.23 | 3.26 | 3.39 |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Δ Change Core CPI | -- | -- | -0.15 | 0.08 | -0.07 | -0.01 | 0 | 0 | 0.06 | -0.03 | -0.13 | -0.23 |
| Trend in Core CPI | -- | -- | Down | Down | Down | Down | Down | Down | Down | Down | Down | Down |
Trimmed Mean PCE Inflation Rate
The Trimmmed Mean PCE Inflation Rate is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, excluding food and energy. The Trimmed Mean PCE tend to be less volatile than the Core CPI and Core PCE, as it is less sensitive to short-term price changes. The Federal Reserve Bank of Dallas calculates the Trimmed Mean PCE by removing the “tails” of the distribution of price changes, which can be more volatile than the overall distribution. This measure is considered a key measure of inflation by the Federal Reserve.
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Trimmed Mean PCE | -- | -- | 2.57 | 2.58 | 2.84 | 2.76 | 2.74 | 2.66 | 2.73 | 2.79 | 2.83 | 2.86 |
| Apr-25 | Mar-25 | Feb-25 | Jan-25 | Dec-24 | Nov-24 | Oct-24 | Sep-24 | Aug-24 | Jul-24 | Jun-24 | May-24 | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Δ Change | -- | -- | -0.01 | -0.26 | 0.08 | 0.02 | 0.08 | -0.07 | -0.06 | -0.04 | -0.03 | -0.1 |
| Trend | -- | -- | Down | Down | Down | Down | Down | Down | Down | Down | Down | Down |
Inflation and Monetary Policy
Inflation and monetary policy are inextricably linked in a complex and dynamic relationship, forming a cornerstone of macroeconomics. Pay attention to the relationship between Federal Funds Rate and inflation (Figure 6).
Learn more here: Monetary Policy Cycle
Wage Inflation
We can not talk about Monetary Policy and inflation without discussing wage inflation.
In Figure 7 illustrates our wage inflation indicator, calculated as the difference between average hourly earnings growth and labor productivity growth. This metric provides a crucial insight into the underlying inflationary pressures within the economy. By isolating the portion of wage increases not offset by productivity gains, we can gauge the extent to which rising labor costs might be contributing to broader price inflation. A sustained positive value, as observed in 2022, suggests that businesses may be facing increased cost pressures that could potentially be passed on to consumers, fueling cost-push inflation. Conversely, a negative value would imply that productivity growth is outpacing wage growth, generally a disinflationary signal.
This indicator serves as a valuable complement to traditional inflation measures, offering a more nuanced understanding of the interplay between wages, productivity, and the overall price level.”
Economic Models and Forecasts
There are a multitude of economic models that attempt to explain and predict inflation, each with its own strengths and weaknesses. Here ar a few prominent ones:
The Phillips Curve: This classic model posits an inverse relationship between inflation and unemployment. The idea is that when unemployment is low, businesses have to compete more for workers, driving up wages, which in turn leads to higher prices. While the Phillips Curve has been a useful tool, its reliability has been questioned in recent decades as the relationship between inflation and unemployment has become less stable.
Quantity Theory of Money: This theory, often associated with Milton Friedman, states that the general price level of goods and services is directly proportional to the amount of money in circulation. In simpler terms, if the money supply grows faster than the economy, we can expect inflation to rise.
Cost-Push Inflation: This model focuses on the supply side of the economy. It suggests that inflation can be driven by increases in production costs, such as wages, raw materials, or energy. These increased costs are passed along to consumers in the form of higher prices.
Demand-Pull Inflation: This model focuses on the demand side. It suggests that inflation occurs when demand for goods and services exceeds supply. This can happen during periods of economic growth when consumers have more money to spend.
Expectations-Augmented Phillips Curve: This model builds on the traditional Phillips Curve by incorporating the role of inflation expectations. The idea is that if people expect inflation to rise, they will demand higher wages and set higher prices, creating a self-fulfilling prophecy.
Dynamic Stochastic General Equilibrium (DSGE) Models: These are complex macroeconomic models that incorporate various factors, including supply shocks, demand shocks, and monetary policy, to predict inflation. They are often used by central banks for policy analysis.
It’s important to note that no single model perfectly captures the complexities of inflation. Economists often use a combination of models and data analysis to understand and forecast inflation trends.
We pay close attention to the interplay of monetary policy, credit cycles, and economic growth in assessing inflationary pressures. For example, excessively loose monetary policy can fuel credit expansion and demand-pull inflation, particularly in the later stages of an economic cycle.