Will "Insurance" Cuts Solve Inflation's Shortfall?
|Despite the current expansion being only weeks away from becoming the longest on record, inflation continues to underperform relative to the FOMC’s 2% target. The year-over-year rate of core PCE inflation briefly brushed 2% a few months last year, but has subsequently fallen back to 1.6%—the average of the current cycle (Figure 1). The persistent shortfall has encouraged speculation that the FOMC may cut interest rates in order to help spur inflation. Our own forecast now looks for the FOMC to cut the fed funds rate 50 bps in the second half of this year, but not because the economy is about to fall into a recession. Rather, ongoing trade tensions are expected to weigh on business investment and slow GDP growth, while less scope to cut the fed funds rate than in prior cycles is likely to make the FOMC more proactive in trying to fend off a slowdown. At the same time, easing would be consistent with the Fed making efforts to meet the price stability side of its mandate. But would such “insurance” cuts fully solve the FOMC’s low inflation problem, and bring core inflation back to 2% on a sustained basis?
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