The US Economy’s Inflation Challenge

IMF News, July 12, 2022

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The US economy has recovered quickly from the pandemic, but the bounce back in demand has stressed supply chains and caused inflation to rise sharply.
Core Personal Consumption Expenditure (PCE) inflation is expected to be brought down to the Federal Reserve’s 2 percent medium-term target by late 2023 under the baseline scenario.
Most workers’ wages have failed to keep up with inflation, eroding the purchasing power of households and causing significant hardship.
Price increases have been broad-based, including gasoline, food, housing, and transportation, and could become long lasting if unchecked.
The IMF concludes that the Fed should act quickly and assertively to tackle inflation and restore price stability.

The Fed increased its policy rates by 1.5 percent so far this year and is likely to increase them by another 2 or 2.5 percent in the coming months.
The Fed is also unwinding its holdings of Treasury bonds and mortgage-backed securities, increasing the cost of borrowing.
Example: the average fixed rate on a 30-year mortgage has risen from 3 percent to between 5 and 6 percent since the start of this year.
Pandemic-era government support programs are expiring and the government is reining in spending.
Expected effects:
- Growth in consumer spending will slow to around zero by early next year, easing strain on supply chains.
- Higher mortgage rates will reduce housing prices.
- Slowing demand will increase unemployment to around 5 percent by the end of 2023, which should decrease wages.
- Core PCE inflation is expected to fall back toward 2 percent by late 2023.
- Economic activity is expected to slow from 3.5 percent in the first quarter of this year to 0.6 percent by end‑2023.

Global factors that could impact US developments include the Russian war with Ukraine, the ongoing pandemic, and possible recurrence of shutdowns in China.
If inflation is more persistent than expected, inflation expectations could move up and feed into wages and prices.
In that scenario, the Fed would need to tighten more aggressively—raising interest rates and keeping them higher for longer—which would lower growth further and lead to higher unemployment.

While tighter Fed policies may impose short-term costs on households and firms, restoring price stability is necessary to lay the foundations for strong growth and low unemployment.
The US government can support medium- to long-term growth through fiscal measures that expand the labor force, improve productivity, and incentivize innovation and investment, including:
- Increased government support for paid family leave, childcare, pre-school, and access to a college education.
- Tax credits that help women, minorities, and lower-income workers join the workforce.
- Immigration reform targeted toward expanding the labor force and strengthening skills.

Andrew Hodge, IMF Western Hemisphere Department — July 12, 2022