Thank you, Dean Dunham and the University of St. Thomas, for the opportunity to speak with you today.1 Since this event is co-sponsored by the Notre Dame Club of Minnesota and I have taught at Notre Dame for 13 years, I will do so Start with this thought: Go Irish!
When I last spoke on January 16, the data we had received up to that point was very good – the three- and six-month measures of core personal consumption expenditures (PCE) inflation were right at 2 percent, which is our overall target Inflation cooled, the labor market cooled but was still healthy, and real gross domestic product (GDP) also grew but is expected to moderate in the fourth quarter. I argued at the time that the data was “almost as good as it gets.” And I argued that because the economy is strong, we could take our time and collect more data to make sure inflation is on a sustainable 2 percent path. There was no rush to cut interest rates any time soon.
Since then, we have received fourth quarter GDP data as well as January data on employment growth and Consumer Product Index (CPI) inflation. All three reports came in hotter than expected. At 3.3 percent, GDP growth was well above forecasts. The number of jobs increased by 353,000, well above forecasts of fewer than 200,000, and core monthly CPI inflation was 0.4 percent, much higher than the previous six months.
The data we have received since my last speech has reinforced my view that we need to check whether the progress on inflation that we saw in the last half of 2023 will continue, and that means there is no rush , to begin lowering interest rates to normalize monetary policy.
Last week's January consumer price report served as a reminder that further progress on inflation is not assured. The rise in inflation in this report spread broadly across goods and services. This one month's data could be due to strange seasonal factors or an outsized increase in housing costs, or it could be a signal that inflation is more stubborn than we thought and it will be harder to bring it back down to our target. We just don't know yet. Although I expect inflation to be on track to reach 2 percent in a sustainable manner, I need more data to determine whether January's CPI inflation was more noise than signal. That means I have to wait longer until I have enough confidence that the beginning rate cut will keep us on track to 2 percent inflation.
Fortunately, strong output and employment growth means there is not much urgency for policy easing, which I still expect we will do this year. More data and more time will show whether January's CPI report was just a stone in the road to 2 percent inflation. The surprisingly unexpected data we received confirms the careful risk management approach that Chairman Powell has taken in his recent public appearances. And with most data pointing to solid economic fundamentals, the risk of waiting a little longer to ease policy is less than the risk of acting too soon and potentially halting the progress we've made on inflation or to undo.
Let me start with the outlook for economic activity, including insights from the latest data. As I mentioned, real GDP grew strongly in the second half of 2023, and this momentum has led forecasters to predict continued solid growth in the first few months of 2024. After growth of 4.9 percent in the third quarter of last year and growth of 3.3 percent in the fourth quarter, according to Clip, estimates for the first quarter of 2024 range from 1.7 percent for the blue-chip average of the forecasters of the private sector up to 2.9 percent for the Atlanta Fed's GDPNow model, which is based on available data.
This recent data includes the Institute for Supply Management's January survey of purchasing managers. For non-manufacturing companies, the index rose to levels consistent with moderate growth. Meanwhile, the manufacturing index, although still declining, rose to its highest level since October 2022, with rising orders and production, continued improvement in delivery times and customer inventories all pointing to favorable demand growth.
While the overall situation suggests that growth has continued at a moderate pace, several indicators point to some slowdown. Retail sales fell 0.8 percent in January after rising 0.4 percent in December. Although some of this decline is likely due to poor weather and technical issues related to seasonal adjustment, it was a surprise. This could suggest that consumer spending, which was higher than I expected in the second half of 2023, is finally showing the impact of higher interest rates and a reduction in excess savings.
I'll be watching to see if spending remains robust. A positive sign is that consumer confidence has continued to rise. One reason for this is likely to be the labor market, whose surprising strength continued in January. As I mentioned, the U.S. economy added 353,000 jobs in January and 333,000 in December, well above the average of 255,000 per month in 2023 and also well above what most estimates suggest is consistent with population growth. Job growth in January was widespread across various sectors of the economy. There were job gains in three major sectors where there were severe labor shortages: health care and social assistance, leisure and hospitality, and state and local government. But there were also significant job gains in parts of the economy that tend to rise and fall with changes in the pace of economic activity — manufacturing, construction, retail and professional business services. Manufacturing and professional services gains were at or near their highest levels in the past 12 months.
Unemployment was stable at 3.7 percent, almost the lowest it has been in 50 years. And while there have been signs of weakening labor demand throughout 2023, those signs haven't been as clear recently. The 12-month growth rate in average hourly wages fell from 4.7 percent in July to 4.3 percent in December and then rose to 4.5 percent in January. For the past two years, I have focused on job vacancies as an indicator of labor demand. The number of job vacancies fell from 12 million in April 2022 to 9 million in December 2023. We won't get data on job vacancies in January for another few weeks, but the number of job openings rose unexpectedly in December and the number of people quitting their jobs remained stable, both signs that moderation is on hold The labor market may have stalled. One data point doesn't indicate a trend, and these strong jobs reports come after a year of more or less steady easing in the labor market, with supply increasing relative to demand. However, it tends to support the idea of continued moderate economic growth. I'll be watching for signs of continued easing in the labor market, which by most measures is still significantly tighter than it was before the pandemic.
Everything about the outlook I've mentioned so far is important for what it tells us about continued progress toward the Federal Open Market Committee's (FOMC) inflation target of 2 percent. Last week's high reading of CPI inflation may be just one obstacle, but it could also be a warning that the significant progress on inflation over the past year may be stalling. While 12-month CPI inflation improved slightly to 3.1 percent, it was higher than expected, as was the 3.9 percent increase in core inflation, which excludes volatile food and energy prices. Both the three-month and six-month changes in core CPI increased in January. The FOMC's preferred inflation measure, based on personal consumption expenditures, is not yet available for January, but an estimate taking producer prices into account puts core PCE inflation at a 12-month rate of 2.8 percent and a three-month rate Six-month rate increased Interest rates rose to 2.4 percent and 2.5 percent, respectively.
Although this upward trend is not a positive development, let's take a deep breath and put it into perspective. A year ago, core CPI inflation was 6.4 percent and core PCE inflation was 4.9 percent. Since then, inflation has fallen by more than half, and this progress continued through December. There was also good news for the annual seasonal adjustment factors this month compared to last year's inflation data. By early 2023, these revisions had shown that inflation in 2022 was much worse than originally estimated, and I was worried that would happen again this year. But the February 9 revisions did not change the picture of a dramatic improvement in inflation in 2023. It is reassuring to know that the progress we have made was real and not a mirage.
In assessing whether January inflation was noise or a sign of slowing progress, one of the things I will be looking at is wage and salary measures. I mentioned the increase in average hourly wages last month. It is true that average wages softened somewhat in the second half of last year, but I still consider them to be somewhat elevated to meet our 2 percent target. Other compensation measures show slow but steady progress toward this goal. The Bureau of Labor Statistics' quarterly employment cost index showed a moderation in both salaries and bonuses in the final three months of 2023. And the Atlanta Fed's Wage Growth Tracker continued its very gradual decline in January. Wages and salaries are the largest expense for most businesses, and I will be watching to see whether wages and other compensation continue to decline or whether they become a factor preventing progress toward our inflation target.
Although I focus on the overall inflation numbers, it is still useful to take a look at how the different components of inflation have performed. An important factor in the improvement in inflation last year was the fall in goods prices in 2023. Goods prices account for nearly 25 percent of core CPI inflation. Even in times of very low inflation, goods deflation is moderate in a growing economy, so the question is whether this contribution to inflation progress will continue.
Another important factor in CPI inflation is the cost of housing services, which measures the estimated cost of renting or the equivalent of owning a home. Housing cost inflation is about 45 percent of core CPI inflation. There has been a fairly steady moderation in housing services inflation in 2023, as the slowdown in market rent increases since 2022 has gradually been reflected in the housing services price index. However, in January CPI data we saw an unexpected rise in housing services inflation. I plan to monitor whether housing costs continue to rise higher than expected.
The remaining component of core CPI inflation is non-residential services. This category makes up about 30 percent of the index. Inflation in this category weakened throughout 2023, but saw a broad-based increase in January. Since business services rely heavily on labor input, this price segment is of course significantly influenced by labor compensation, such as wages and benefits. One question, then, is whether relatively high labor costs prevent this large component of inflation from moderating.
Looking at all of these aspects of inflation, I have to say that I see mostly upside risks to my overall expectation that inflation will continue to move toward the FOMC's 2 percent target. On the other hand, given the strong economic fundamentals we are seeing in terms of GDP and employment, I see little reason to believe that inflation will remain below 2 percent for an extended period of time. For these reasons, I need to look at the inflation data for a few more months to make sure that January was a fluke and that we are still on the path to price stability.
This brings me to the implications of this outlook for monetary policy. Let me pause here and say that the FOMC typically only considers easing monetary policy when there are fairly clear signs that the economy may be in or near recession. But based on the picture of the economy I painted today, it should be as clear to you as I am that there are no signs of an impending recession. By that I don't mean that the economic picture is crystal clear. Looking through the data, I see evidence of continued robust growth in output and employment, but also some signs that growth may be slowing. What is clear is that the U.S. economy is healthy in many respects and well positioned to continue growing and creating new jobs. This is a good result and our job is not to stop it, but rather to ensure that economic fundamentals grow in line with 2 percent inflation.
That makes the decision to be patient with policy easing easier than it could be. I need to see inflation data for at least a few more months before I can judge whether January was a brake pedal or a pothole. I will be keeping an eye on the wages and salaries as well as the components of inflation that I described today to see whether the overall progress on inflation continues or stalls. I will also be monitoring economic activity and employment, paying attention as always to unexpected warning signs of recession, but also paying close attention to whether growth in both areas is consistent with continued progress toward a 2 percent inflation rate.
I still expect that it will be appropriate to start easing monetary policy at some point this year, but the start of monetary easing and the number of rate cuts will depend on the upcoming data. I also don't know whether the economy and employment will continue to advance or whether both will slow in a way that I think will support progress toward a 2 percent inflation rate. But the bottom line is that I think the committee can wait a little longer to ease monetary policy.
Commentators often argue that by delaying rate cuts for a session or two, we run the risk of adopting too strict a policy that could lead to a short-term recession. Although I find this narrative interesting, I also find it somewhat puzzling. The reason is as follows. When interest rates rise, much of the discussion revolves around the long and variable lags in monetary policy, with rate hikes not having a serious impact on the economy for 18 months or longer. But by delaying interest rate cuts for a short period of time, we supposedly risk suddenly pushing the economy into recession. This alleged asymmetry in the lagged effects of rate increases versus rate cuts is puzzling and is not supported by any economic model that I know of.
How do we square this narrative? I think the explanation is, as I mentioned, that interest rate cuts typically come after large economic shocks that trigger or threaten to trigger a recession. Historically, large and rapid interest rate cuts are highly correlated with recessions, leading to the conclusion that policy was too restrictive and actually caused a recession. But it is very difficult to distinguish the effects of tight monetary policy from a major economic shock when looking at past recessions in the US. We have no counterfactual about what impact delayed rate cuts would have had on the economy in the absence of the economic shock. My guess is that delaying interest rate cuts by a few months without a major economic shock is unlikely to have a significant impact on the real economy in the short term. And I believe I have shown that acting too soon could reverse our progress on inflation and cause significant damage to the economy.
In summary, the strength of the economy and the recent data we have received on inflation make it appropriate to be patient, careful, methodical and deliberate – choose your favorite synonym. Whatever word you choose, they all translate to one idea: What is the rush?
1. The views expressed here are my own and not necessarily those of my colleagues on the Federal Open Market Committee. Back to text