Is the US economy headed for inflation?

Key takeaways

  • Thursday's GDP report presented a paradox: The economy is growing in all the right places (for example, the job market) but in all the wrong places (prices).
  • Some investors and economic watchers fear the U.S. may be entering a period in which the cost of living continues to rise, known as stagflation.
  • Details of the economists' report show that the concern is unfounded.
  • However, it complicates the job of Federal Reserve officials, who are trying to rebalance economic growth and inflation as they decide whether to cut interest rates.

In the post-pandemic era, the U.S. economy has had a unique upside and downside: a good job market and fast economic growth, at the expense of stubbornly high inflation.

But Thursday's gross domestic product (GDP) report raised the possibility that that rapid growth will slow, while the cost of living continues to rise — a combination of a stagnant economy and inflation.

Many economists downplayed concerns about potential stagnation. In recent months, the economy appears to be headed for a „soft landing” from post-burst inflation rather than recession, and many experts think the economy is still on that path. flat

There were some warning signals in Thursday's data. GDP grew at a 1.6% annual rate in the first quarter, well below economists' 2.2% average forecast, while inflation, as measured by personal consumption expenditures, rose to 3.4% from 1.8% in the previous quarter, beating expectations.

The 'disappointment' is in the details

But digging into the details, some economists say the picture isn't as dire as it appears on the surface.

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„You'll hear a lot about stagnation today. Ignore it,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote on social media site X.

One is the slowdown in GDP growth, which was affected by the increase in imports. Because of the way GDP is calculated, imports reduce GDP while indicating that people spend a lot of money buying goods from abroad.

In fact, consumer spending on services is accelerating even as households appear to be cutting back on big-ticket items, economists at Wells Fargo Securities said in a research note.

In other words, GDP is „disappointing for all the right reasons,” Gregory Dago, chief economist at EY Parthenon, posted in X .

Also, Taco pointed out that the tepid inflation figures were largely inflated by „financial services” spending, which was influenced by stock prices rather than broader inflationary trends.

Federal Reserve Rate Hikes 'Not Working'

Starting in March 2022, the Federal Reserve has fought inflation by raising its key interest rate, raising borrowing costs to cool the economy and encouraging spending at the risk of triggering a recession. Although interest rates are currently at a 23-year high, the economy could be on track to continue its rapid growth, for better or for worse.

„Higher rates are likely to cool consumer demand,” Wells Fargo Securities economists Tim Quinlan and Shannon Seery Crane wrote in a commentary. „The Central Bank's Problem: It Doesn't Work.”

The central bank's inflation target will be released on Friday morning, providing another opportunity to assess the impact of higher rates. Fed officials have repeatedly said they need more confidence that inflation is heading toward the central bank's 2% target before cutting the benchmark interest rate.

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