A Forecasting Personality Test

Alternatively, you might be an infla­tion pessimist. You might point to continued strong wage growth in a tight labor market. You might note consum­ers' continued willingness to spend; the saving rate is down to 3.6 percent versus 7.7 percent pre-pandemic, and that spending is potentially support­ing higher prices. Or maybe you notice other forces that arguably have turned inflationary, from deglobalization to limited housing supply to demographics to energy transition.

Lastly, you might be a Fed pessimist. You might fear the Fed will keep rates too high for too long or normalize too quickly and allow inflation to linger. Our job isn't easy, and history teaches that most tightening cycles end poorly, though often heavily influenced by an outside event like the pandemic or the 1990 Gulf War.

What do I see?

On demand, I have to believe all of this tightening will eventually slow the economy further. After all, corporate interest payments as a percent of corpo­rate revenues and personal interest payments as a percent of disposable personal income have only now finally gotten back in the range of 2019 levels — suggesting the full impact of higher rates is yet to come.

If the economy does cool, it doesn't need to be as painful as the Great Recession. Employers who have fought hard to recover from labor short­ages tell me they are hesitant to lay people off and run the risk of being short again. And a slowdown shouldn't catch businesses by surprise; they've already slowed hiring and streamlined costs. Banks have cut back on marginal credit. In short, the economy should be less vulnerable.

On inflation, while I do hear price-setters increasingly convinced that the pandemic era of significant pric­ing power is behind them, the infla­tionary experience of the last two years has surely given them more cour­age to use price as a lever. (See "How the Pandemic Era Changed Price-Setting," Econ Focus, Fourth Quarter 2023.) So I'm still looking for the slow­ing in reported inflation to sustain and broaden.

Despite my concerns about demand and inflation, perhaps it is no surprise that I'm a Fed optimist, which is differ­ent than believing we are infallible. I am optimistic that keeping rates somewhat restrictive can bring infla­tion back to our target. While I don't see the economy overheating, the Fed knows how to respond if it does. And if the economy slows, the Fed has enough firepower to support it as necessary.