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Inflation is coming down but the Fed isn't about to declare victory just yet

A MARTÍNEZ, HOST:

Inflation is coming down, but the watchdogs at the Federal Reserve aren't ready to declare a victory just yet.

STEVE INSKEEP, HOST:

Instead, the Fed is expected to order another boost in interest rates today. The central bank is trying to hold down inflation. Today's rate hike is expected to be smaller than the last six.

MARTÍNEZ: NPR's Scott Horsley joins us now. Scott, there's been some encouraging inflation news lately. So what's the Fed looking at as it makes its decision today?

SCOTT HORSLEY, BYLINE: That's right. Most of the recent data has been encouraging. After hitting a four-decade high last summer, inflation has come down a good bit. It's still higher than the Fed would like, but it's moving in the right direction. Wage gains have also cooled off despite the tight job market. And that's reassuring to the Fed, which worries that if wages go up too fast, that could put more upward pressure on prices. Economist Aaron Sojourner, who's with the Upjohn Institute for Employment Research, says this gradual slowdown in both price increases and wage increases is pretty much exactly what the Fed wants to see.

AARON SOJOURNER: If you were writing the description of what a good resolution to the crises we've been in looks like, this is what it looks like.

HORSLEY: But the Fed is not celebrating just yet. Officials say they are encouraged by what they're seeing, but warn we're not yet out of the inflationary woods.

MARTÍNEZ: All right. So what does that mean for interest rates?

HORSLEY: The Fed is almost sure to raise rates by a quarter percentage point today. That would be the smallest increase since last March. After raising rates really aggressively last year, Fed policymakers are now shifting to more of a go-slow approach so they can take the temperature of the economy and see where they want to go from here. Now, financial markets are betting the Fed is going to pivot pretty soon and actually start cutting interest rates. That's one reason the stock markets enjoyed a big rally in recent weeks. But Fed officials have said repeatedly that's not going to happen. Here's Fed Governor Chris Waller speaking a couple of weeks ago.

(SOUNDBITE OF ARCHIVED RECORDING)

CHRISTOPHER WALLER: The market has a very optimistic view that inflation is just going to melt away. We have a different view. Inflation is not going to just miraculously melt away. It's going to be a slower, harder slog to get inflation down. And therefore, we have to keep rates higher for longer.

HORSLEY: Remember, just a couple of years ago, it was the Fed that thought inflation would melt away on its own once the pandemic eased and supply chains came untangled. Of course, those price hikes proved to be larger and longer lasting than the central bank expected. And Waller says they don't want to make that mistake and get head faked again.

MARTÍNEZ: But is there a chance that they're making a different mistake, the opposite mistake, by being too conservative?

HORSLEY: Yes. And that's why the Fed is being cautious now and gradually downsizing these rate hikes. The challenge that Fed policymakers are wrestling with is that monetary policy works kind of like the shower in my creaky, old house. You know, you turn the knobs, but the water temperature does change right away. And if you're not careful, you can overcorrect. And then suddenly, whew, you get hit with this icy blast. You know, the Fed has been turning the cold water tap on the economy with these rate hikes now for the better part of a year. And we're only now starting to feel the effects. Consumer spending is slowing. Job growth has cooled a little bit. Ideally, inflation will settle gently back down to the Fed's 2% target. Turn the knobs too far, though, and we wind up shivering through a painful recession.

MARTÍNEZ: Cold showers are not bad, Scott. They wake me up. That's NPR's Scott Horsley. Scott, thanks.

HORSLEY: You're welcome. Transcript provided by NPR, Copyright NPR.

A Martínez is one of the hosts of Morning Edition and Up First. He came to NPR in 2021 and is based out of NPR West.
Scott Horsley is NPR's Chief Economics Correspondent. He reports on ups and downs in the national economy as well as fault lines between booming and busting communities.