The Federal Reserve’s second-in-command offered an upbeat analysis of the U.S. inflation situation on Thursday, stressing that many of the factors that have driven prices higher in recent years may be fading.
“It remains possible that continued easing in aggregate demand could facilitate continued easing in the labor market and lower inflation without significant job losses,” Lael Brainard, the Fed’s vice chairman, said in a speech at the University of Chicago Booth School. business.
Ms. Brainard’s comments came just days before Fed officials prepare to begin a quiet period ahead of the Feb. 1 interest rate decision.
In some ways, Ms. Brainard broke with what her colleagues were saying about the forces that could keep inflation high. Many central bankers have emphasized the role that a tight labor market and strong wage growth are likely to play in fueling price rises, but Ms. Brainard focused on other factors that have accelerated price increases, particularly in services.
“There are a range of views on what it will take to bring this component of inflation down to pre-pandemic levels,” Ms. Brainard acknowledged in remarks. She noted that wages are an important cost for service firms, so “one possible channel is the weakening of labor demand.”
But she added that “to the extent that non-wage inputs may have been partly responsible for the important price increase”, a turnaround in these factors could help reduce services inflation.
In particular, Ms. Brainard noted that supply chain issues and spikes in fuel prices may be coming through to increase some utility costs, and those could fade, provided supply chains continue to heal and gas remains relatively cheap.
And Ms. Brainard also cited a reversal of inflated profit margins as something that could help moderate inflation.
Companies have enjoyed an unusual surge in pricing power during the pandemic, as recurring supply chain issues and resilient consumer demand have given them reason to try to raise prices and the means to do so without deterring shoppers. Many firms raised what they charged more than needed to cover the cost of the climb, increasing their profits.
“Labour’s share of income has declined over the past two years and appears to be at or below pre-pandemic levels, while corporate profits as a share of GDP remain close to post-war highs,” Ms Brainard said.
But that may change as demand declines and price sensitivity returns.
“The compression of these markups due to easing supply constraints, rising inventories and cooling demand could add to disinflationary pressures,” she said.
The Fed is expected to raise interest rates again at its upcoming meeting as it seeks to bring rapid inflation back under control. Officials slowed from a series of three-quarter-point moves in 2022 to a half-point move in December, and several indicated they would favor slowing to a quarter-point move at the February meeting.
While Ms. Brainard did not speculate in her prepared remarks on how much of a rate move would be warranted, she emphasized that borrowing costs would need to remain high to ensure full easing of inflation.
“Policy will need to be sufficiently restrictive for some time to ensure that inflation returns to 2 percent on a sustained basis,” she said.