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The latest inflation report points to a hard truth: The US is not going back to a 2% inflation rate anytime soon. At least not easily.
It’s clear, as inflation picks up and real wages continue to fall, that the period of smooth disinflation is over. The reasons could be government policy — on trade, immigration or energy — but for the consumer or the Federal Reserve’s credibility, none of that matters. The US economy is built for 2% inflation, Fed Chair Kevin Warsh has promised to reach that target, and the rate of inflation is higher than that.
The Fed has some tools to reduce inflation. The question is whether it is willing to use them. A rate hike or two, which the market is already anticipating, probably won’t be enough to do the job.
Here’s why: If inflation is up because of high demand and a hot economy, a few rate hikes can increase the cost of capital and signal the Fed’s commitment to fighting inflation. This will have the effect of tempering expectations and, ideally, reducing the rate of inflation.
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Allison Schrager is a senior fellow at the Manhattan Institute, a contributing editor of City Journal, and a Bloomberg Opinion columnist.