The US's fight against inflation is either dragging the economy into a recession or swimmingly.
In recent weeks, policymakers at the Federal Reserve have made it clear that they will not stop raising interest rates until inflation returns to 2%. The central bank hiked rates again on Wednesday to the highest level since 2008.
The effort might pull the US into a period of subpar growth and higher unemployment, but allowing inflation to rage on would bring far greater pain.
The majority of Americans don't think a recession is necessary. The public's expectations of future inflation are decreasing as prices for key goods decrease. Households think the worst is over, but they think inflation will go down over the next few years.
The effects of inflation expectations can be dramatic. Inflation can be a prophecy. Americans want higher wages when they expect prices to go up. Businesses usually raise prices in kind. As wages rise faster and prices go up, a vicious cycle can start.
In the other direction, the dynamic works as well. Businesses are pushed to compete with each other if inflation expectations are anchored as consumers reject large price hikes.
This is what's happening today. Households view the price surge as more of a temporary spell than a crisis, as average inflation expectations have fallen since June. The New York Fed's Survey of Consumer Expectations shows that the expected inflation rate has fallen. The median three-year ahead expected rate fell to 2.8% from 3.2%, the lowest reading in more than a year.
Powell said on Wednesday that well-anchored inflation expectations were a boon, but that the trend was not grounds for optimism.
Expectations of higher inflation will become entrenched if the current bout of high inflation continues.
The decline continued into the fall according to surveys. The Conference Board said consumer confidence rose for a second month in a row in September. Lynn Franco, senior director of economic indicators at The Conference Board, said that fears of rampant inflation have dissipated further.
Inflation will come down over the next few years, according to markets. The 5-year breakeven inflation rate fell to 2.33% on Monday, the lowest it's been in over a year. As the Fed began its hiking cycle, the downtrend began. The recent trend shows investors are betting on a continued cooling off.
Americans are putting their money where they want it to go. Inflation-adjusted sales at retailers and restaurants have fallen from the April peak as shoppers shy away from expensive goods. Bank of America's card data shows wealthier households cutting back on their spending.
The Fed's mission to curb inflation is based on what it has learned from the past. When expectations broke out of the years-long trend, the inflation spell of the 1970s was made worse. It took high interest rates and a recession to bring price growth to heel.
Today's economy is not likely to see a break out like this. According to a former Fed and White House economist, inflation expectations only matter to the extent that they change behavior.
She said that it took a decade of high inflation to create it. Aggressive tightening on fears of de-anchoring is not justified.
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