The Recovery of the Service Sector from the Great Depression to the First Day of the Fed’s First Year in Charge: A Rejoinder for the Economy
The cost of services such as travel and restaurant dinners is still rising, even though inflation has cooled thanks to falling gasoline prices.
Between February and March the prices were little changed. The rising cost of shelter accounts for much of that increase. The food and energy prices were unchanged.
“Inflation remains too high, although we’ve seen welcome signs over the past half year that inflation has moderated,” Treasury Secretary Janet Yellen said this week. Commodity prices have fallen. Supply-chain snarls are being resolved. The global financial system has held up well.
The collapse of two big regional banks last month has made it hard for the Fed to control inflation.
That acts like an additional brake on the economy, amplifying the Fed’s own rate hikes. Fed policymakers will have to weigh the uncertain effects of those tighter credit conditions in deciding how much higher interest rates need to go.
“The Fed’s job is to be more paranoid than anyone else. “That is what they pay the Federal Reserve Bank of Chicago for,” said Goolsbee this week. “We have to dig into a lot of new information when we’re in more interesting times, like the times we’re currently in.”
Goolsbee told the Economic Club of Chicago Tuesday that the most worrisome price hikes today are in the services sector, which was pummeled early in the pandemic and still hasn’t adjusted to a rapid rebound in demand.
Goolsbee said that the economy is coming back from bad times. “Goods inflation has come down a lot,” he said. It has proved particularly persistent that services inflation has returned and was repressed for a short period of time.
Unlike housing and manufacturing, which are especially sensitive to rising interest rates, the service industries may be less responsive to the Fed’s inflation-fighting moves.
One encouraging sign for the Fed is that wages — an important factor in service prices — have cooled in recent months. Average wages in March were 4.2% higher than a year ago, compared to a 4.6% annual increase in February.
There are some indications that inflation will fall further. The flood of cash that people got from the government during the pandemic is drying up, reducing consumer demand. The supply chain was much calmer than the earlier Covid days. The price of oil and gas has come down after Russia invaded Ukraine. The Federal Reserve, in an effort to further restrain demand, has increased interest rates to make borrowing money more expensive.
Going forward, policymakers will probably try to take a balanced approach to match the mixed story. The Federal Reserve is likely to take more measured steps than it did last year. The central bank raised its benchmark rates several times in a row, but then adopted a smaller quarter-point increase last month, and is expected to do the same at its next meeting in May.
There is a risk that the Fed does too little and inflation persists, as happened in 2021. But there is also a risk that the Fed goes too far and does unnecessary damage to the economy, as this newsletter has explained before. A strong economy can lead to faster price increases. A weak economy can cause a lot of people to be out of work. Policymakers are trying to find a sweet spot between those two extremes.