And this combination of events is likely to create an environment in which business investment spending will gather strength. Finally, I believe this tug-of-war analogy is useful in explaining the recent inflation dynamics. As is well known, total inflation, as measured by the personal consumption expenditures (PCE) deflator, has slowed sharply over the past year and is now running below the FOMC’s expressed goal of 2 percent. Much of the slowing of total inflation is due to declining energy prices resulting from the weakening of global growth mentioned earlier combined with increased energy production here in the U.S. However, it is also the case that core inflation, that is, excluding food and energy, has slowed sharply as well. A decomposition of the slowing in core inflation reveals that some of it is due to slowing in the rate of increase in prices of non-food and non-energy goods. This probably is due in large part to the softening of global demand for goods and the modest appreciation of the dollar that has occurred since mid-2011. In the service sector, the rate of increase in prices of medical services and “non-market” services – the latter includes some financial services – also has slowed notably recently. In contrast, the rate of increase in prices for other non-energy services has been relatively stable.
Comparing this set of conditions to that in 2010, the recent slowing of inflation has been less widespread across core goods and core services, and inflation expectations so far have declined less appreciably than they did in 2010. Thus, my best guess is that core goods prices will begin to firm in the months ahead as global demand begins to strengthen and inventories get into better alignment with sales. 1  2  CoreLogic Report Shows Home Prices Rise by 12.1 Percent Year Over Year in April. BIS central bankers’ speeches  As is always the case, there is substantial uncertainty surrounding this forecast. Moreover, there is always the possibility of some unforeseen shock. Thus, we will be monitoring U.S. and global economic conditions very carefully and will adjust our views on the likely path for growth, inflation and the unemployment rate accordingly in response to new information. At its meeting last week, the FOMC decided to continue its accommodative policy stance. It reaffirmed its expectation that the current low range for the federal funds rate target will be appropriate at least as long as the unemployment rate remains above 6.5 percent, so long as inflation and inflation expectations remain well-behaved. It is important to remember that these conditions are thresholds, not triggers. The FOMC also maintained its purchases of $ billion per month in agency MBS and $ billion per month in Treasury securities, with a stated goal of promoting a substantial improvement in the labor market outlook in a context of price stability.