Inflation Is Trending Down Again, But….

The inflation rate has gone down for the past two months and is now barely above 2 percent. Here’s a chart showing the Consumer Price Index for the past five years:

Given this, should the Fed still be raising interest rates? It’s beginning to look like there’s no real acceleration in inflation at all. Let’s take a look at a longer-term chart that shows both inflation and interest rates:

What you can see in this chart is something you already know: when inflation rises, the Fed responds with higher interest rates and this generally leads to a recession. The main exception to this trend comes in the mid-90s, when the Fed raised interest rates to 6 percent even though inflation was falling.

This doesn’t mean that Fed actions are solely responsible for all recessions. Oil price spikes play a big role. The housing bubble obviously played a huge role in 2008. Still, as a general rule, when inflation rises more than about 2-3 points, the Fed usually responds and helps to tip the economy into recession. Right now, the Fed Funds rate has increased about 2 points over the past two years, which is a historically modest response. If they don’t go much further, I’d guess that their actions so far turn out to be pretty innocuous.¹ And with inflation still well in check, they really have no reason to keep going until they hit a 3 percentage point rise. I sure hope they agree.

¹Assuming some external event doesn’t do the job for them. A big oil price spike or a huge housing bubble could certainly cause a recession with little or no help from the Fed. Speaking of which:

And this:

Housing prices haven’t reached their 2016 peak, and oil prices haven’t spiked sharply over the past couple of years. Still, housing prices are up 40 percent since 2012, and oil prices are up 160 percent over the past two years. Those are pretty fair increases.

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