John C Williams: Peeling the inflation onion, revisited
Remarks (virtual) by Mr John C Williams, President and Chief Executive Officer of the
Federal Reserve Bank of New York, prepared for a regional visit to Long Island, 29
September 2023.
* * *
The Federal Reserve has two main monetary policy goals, often referred to as the "dual
mandate": maximum employment and price stability. As I will discuss in more detail, we
are doing well on our maximum employment mandate, but we still have a ways to go to
fully restore price stability.
Although inflation has come down from the peak reached last year, it is still too high.
Price stability is the bedrock upon which our economic prosperity and stability stands.
The Federal Open Market Committee (FOMC) has set a 2 percent longer-run goal for
inflation and is committed to attaining that goal on a sustained basis.1
Before I go any further, I must give the standard Fed disclaimer that the views I express
today are mine alone and do not necessarily reflect those of the FOMC or others in the
Federal Reserve System.
The Inflation Onion
After peaking at just over 7 percent in June of last year, inflation is now 3-1/2 percent,
based on the 12-month percent change in the personal consumption expenditures price
index. To understand why inflation rose so much and how it's coming back down, I find
it useful to use the metaphor of an onion with various "layers" of inflation.2
The outer layer of the onion consists of prices of globally traded commodities-lumber,
steel, grains, and oil. The pandemic caused global demand for commodities to
skyrocket. Russia's war against Ukraine set off a second sharp rise in commodity
prices. Since then, global demand has come into better balance with supply, and
inflation in this layer has come down significantly.
To give an idea of how big the swings in these inflation rates have been, food price
inflation soared to over 10 percent and energy price inflation skyrocketed to over 40
percent in June of last year. Over the past 12 months, as supply-demand imbalances
receded, food price inflation dropped to about 3 percent, and, despite the recent
rebound in oil and gasoline prices, energy prices have declined by about 3-1/2 percent.
The middle layer of the onion is made up of goods like appliances, furniture, and cars.
In the pandemic and its aftermath, demand for goods rose, supply-chain disruptions
contributed to shortages, and prices increased sharply. Today, demand for goods has
lessened, in part due to higher interest rates, and supply chain bottlenecks have
improved dramatically, resulting in a sharp drop in the inflation rate for goods excluding
food and energy to around 1/2 percent.
Economists at the New York Fed developed a useful tool to measure the extent of
3
supply chain disruptions, called the Global Supply Chain Pressure Index. This index
shot up to an all-time high reading in late 2021, reflecting the wide range of delays, cost
increases, and impediments to supply chains that hampered production and movement
of goods during the pandemic. Since then, these issues have mostly been resolved,
and the index is now indicating favorable overall supply chain conditions. Research at
the New York Fed shows there is a strong relationship between this index and prices of
goods, which helps explain the big swings in goods price inflation over the past two
years.4
The center layer of our onion is underlying inflation, which includes measures for shelter
and other non-energy services. This is the most challenging layer of inflation, as it
reflects the overall balance between supply and demand in the economy and tends to
change more slowly. Shelter inflation has been one of the most important drivers of the
rise in inflation over the past few years, reflecting increased demand for housing and
limited supply. This category of inflation has been coming down gradually, and data on
rents for newly signed leases points to further declines in shelter inflation in coming
months.
Overall, we are seeing inflation moderate in the three layers of the onion, with the
fastest and largest improvements in the outer layers, and progress in the innermost
layer more muted. Two useful metrics capture these shifting inflation dynamics.
The first is nearer-term inflation expectations. According to the New York Fed's monthly
Survey of Consumer Expectations, one-year-ahead inflation expectations have fallen
dramatically since peaking at near 7 percent last June, and are now only about 3/4
5
percentage point above average levels seen over 2014-2020. Medium-term
expectations in the survey are fully back to pre-pandemic levels.6
The second is the New York Fed's Multivariate Core Trend (MCT) inflation, a statistical
method that slices and dices the data to measure the underlying rate of inflation in the
economy. The July reading of MCT inflation was 2-3/4 percent, a huge improvement
over the 5-1/2 percent reading we saw last year.
Labor Markets: Returning to Balance
I'll now turn to the other side of our mandate, maximum employment. The overall labor
market is strong, as seen in the unemployment rate of 3.8 percent, which equals my
estimate of the unemployment rate expected to prevail in the economy in the longer
run. Indeed, the issue we have been facing is that labor demand exceeds available
supply, and this imbalance has contributed to high inflation, especially in the services
sector.
There are numerous signs that labor market imbalances are diminishing. The rate of
people quitting jobs and the rate of new people being hired have moved back to
prepandemic levels. Surveys of employers and households both show a return to pre-
pandemic conditions. The number of job openings, while still high by historical
standards, has declined toward more normal levels. And wage growth has slowed
considerably from earlier peaks.
Both lower demand and improved supply have helped restore balance to the labor
market. Labor supply has rebounded through increases in labor force participation and
immigration. But there are limits to how much further supply will increase going forward,
and further reductions in demand are needed to bring balance to the labor market.
Monetary Policy and the Economic Outlook
Against this backdrop of still-high inflation, the FOMC has set a restrictive stance of
monetary policy to restore balance in the economy and bring inflation down to 2 percent
over time. Last week, the FOMC kept the target range for the federal funds rate
unchanged at 5-1/4 to 5-1/2 percent.7
Our monetary policy actions are having the intended effects, but will take time to fully
work their way through the economy and inflation. As monetary policy continues to
bring demand into better balance with supply, I expect GDP growth to slow next year to
about 1-1/4 percent and the unemployment rate to rise modestly to a little over 4
percent. I foresee inflation of around 3-1/4 percent for this year as a whole, declining to
around 2-1/2 percent next year, before closing in on 2 percent in 2025.
My current assessment is that we are at, or near, the peak level of the target range for
the federal funds rate. I expect we will need to maintain a restrictive stance of monetary
policy for some time to fully restore balance to demand and supply and bring inflation
back to our 2 percent longer-run goal.
Conclusion
In conclusion, monetary policy is having the desired effects on the economy and
inflation. The future is inherently uncertain. As we work to achieve our dual mandate
goals, we face two-sided risks. Our decisions, as always, will be guided by the data,
with our eyes squarely on our goals.
1
Board of Governors of the Federal Reserve System, Statement on Longer-Run Goals
and Monetary Policy Strategy, adopted effective January 24, 2012; as reaffirmed
effective January 31, 2023.
2
John C. Williams, A Bedrock Commitment to Price Stability , remarks at the 2022 U.S.
Hispanic Chamber of Commerce National Conference, Phoenix, Arizona, October 3,
2022; John C. Williams, Peeling the Inflation Onion , remarks at the Economic Club of
New York (delivered via videoconference), November 28, 2022.
3
Federal Reserve Bank of New York, Global Supply Chain Pressure Index .
4
Ozge Akinci, Gianluca Benigno, Ruth Cesar Heymann, Julian di Giovanni, Jan J. J.
Groen, Lawrence Lin, and Adam I. Noble, "The Global Supply Side of Inflationary
Liberty Street Economics
Pressures ," Federal Reserve Bank of New York , January 28,
2022; and Ozge Akinci, Gianluca Benigno, Hunter L. Clark, William Cross-Bermingham,
and Ethan Nourbash, " How Much Can GSCPI Improvements Help Reduce Inflation? ,"
Federal Reserve Bank of New York Liberty Street Economics , February 22, 2023.
5
Federal Reserve Bank of New York, Households Less Optimistic about their Financial
Situations , September 11, 2023.
6
John C. Williams, A Steady Anchor in a Stormy Sea , remarks at SNB-FRB-BIS High
Level Conference on Global Risk, Uncertainty, and Volatility, Zurich, Switzerland,
November 9, 2022.
7
Board of Governors of the Federal Reserve System, Federal Reserve Issues FOMC
Statement, September 20, 2023.