“It turns out that inflation was transitory after all; it just took longer.” Such a view is being heard a lot following the sharp fall in US CPI inflation from a high of 9.1 per cent in June 2022 to its latest November reading of 3.1 per cent. Yet it is an interpretation that is misleading, and it is one that puts even more pressure on the US Federal Reserve to prematurely pursue big and early cuts in its policy interest rates.
My discomfort with the return of the transitory narrative is not because of the complexity of “the last mile” in the battle of inflation. Yes, the outright deflation in the goods sector could well reverse before the disinflation in services accelerates sufficiently to ensure a smooth convergence to the Fed’s 2 per cent inflation rate. Yes, core inflation is proving more stubborn than the energy-led fall in headline inflation. And yes, there are genuine questions about the lagged impact of past rate rises and the appropriate inflation target for an economy with an insufficiently flexible supply side over the medium term.
These are all valid issues that are insufficiently internalised by markets. But even if the path to the Fed’s 2 per cent target was smooth from here, which it won’t be, the “it just took longer” formulation is flawed. At the most fundamental level, it ignores the series of consequential changes that have been caused by the persistency of high inflation for more than two years.