Inflation and the U.S. Economy

Inflation is showing signs of slowing down while the U.S. economy continues its growth. However, there is still room for improvement according to the Federal Reserve (Fed). Inflation levels are considered too high for both the Fed and the general public, and the economy is experiencing strains due to higher interest rates.

Upcoming Economic Readings

The upcoming week will provide valuable insights into inflation and the state of the economy. Two key indicators to look out for include the PCE price index and the fourth-quarter report on gross domestic product.

PCE Price Index

The PCE price index is the Fed's preferred inflation gauge. While it may not be as well-known to the general public compared to the consumer price index, it holds significant weight. The PCE price index differs in calculation methodology from other indices.

Of particular interest to the Fed is the part of the PCE index that excludes food and energy. This core PCE index is seen as the most reliable indicator for predicting future inflation trends.

According to a survey conducted by The Wall Street Journal, economists forecast a modest 0.2% rise in the core PCE index for December. This would be a slight increase from the previous month. If this projection holds true, the annual rate of increase in the core rate would decrease from 3.2% to 3%.

Fed's Inflation Target

The Fed's objective is to bring the headline rate of inflation down to 2%, returning to pre-pandemic trends. A quicker decline towards this 2% mark would prompt the Fed to consider interest rate cuts sooner, which would stimulate the economy.

In an effort to control inflation, the Fed raised interest rates starting in spring 2022. However, this decision has resulted in added stress on the economy due to higher borrowing costs.

The Federal Reserve aims for both lower inflation and sustained economic growth, and it continues to monitor these indicators closely.

The Resilient Economy in the Face of Challenges

Despite higher interest rates, the current three-year-old economic expansion remains intact. The economy has displayed remarkable resilience, as evidenced by the surge of 4.9% in GDP during the third quarter - the official measure of economic performance.

Mild Growth Expected in the Fourth Quarter

Although the recently ended fourth quarter is projected to show more modest growth, with estimates pegging the increase in GDP at 1.7% by the end of 2023, some indicators like the Atlanta Fed's GDPNow tool suggest growth exceeding 2%. This level of growth is still considered impressive, considering that economists believe the sustainable speed limit for the U.S. economy is around 1.8%.

Consumer Spending: A Driving Force

What stands out is the notable resilience of consumer spending in the face of high inflation and rising interest rates. Consumer spending plays a significant role, driving over two-thirds of the U.S. economy. It is expected that consumer spending led the charge once again in the fourth quarter, with early evidence indicating a successful holiday shopping season.

Challenges for the Business Sector

On the other hand, the business side of the economy has not been as robust. Certain sectors, particularly manufacturing, have encountered difficulties and experienced slower growth.

Government Spending Impact

Government spending, another crucial pillar of the economy, is also expected to weaken slightly. Although government outlays have contributed to GDP growth in recent years, their impact is predicted to lessen in the near future.

Despite these challenges and potential slowdowns in certain areas, the economy has displayed resilience and continues to perform well overall.