Good news on inflation means Federal Reserve should back off on further interest rate hikes

Many hate inflation, for reasons both rational and not. The good news is that inflation is in retreat, having fallen every month the past half-year with trends continuing downward. Several reasons are in play for falling prices, but let’s quickly review two that impact many: what economists call “non-core inflation” items, such as food and fuel.

On the rational side of the ledger, people dislike the uncertainty inflation introduces into family budgets. This is especially true for financially stretched working Americans when food and energy prices are rising, as they dramatically spiked in the first half of 2022. For people on tight budgets, essentials, such as gas and groceries prices can become unaffordable if their cost heads north. War and transportation costs drove energy and food prices to painful highs this summer.

Two chief factors since have brought energy prices down. One, the Biden Administration sensibly tapped the US’s strategic oil reserves, thus reducing supply pressures until energy markets stabilized. Further downward price pressure on fuel has come from Europe’s unusually, if not somewhat unsettling, balmy winter. Petrol prices in Wisconsin now hover around $3 a gallon (or, inflation adjusted for some perspective to when President Obama left office and Trump assumed office, to about $2.50 in 2017 prices). And now that oil prices have stabilized, the US government will begin anew oil purchases in February to replenish the Strategic Oil Reserve.

Meanwhile, natural gas prices on global spot markets have fallen to their pre-Russia/Ukraine war lows despite the US exporting more of its natural gas than ever. That said, the temporary energy price spike this summer was successfully leveraged by many utility companies to put in place higher rates for consumers (less for businesses) going forward. Those prices will not fall, but neither will they rise again anytime soon. Moreover, the past year big oil/gas sat on the sidelines as their prices collapsed in 2021. Many US fracking operations that required substantial external financing went bust when prices plummeted. Prices rose again in 2022 with the Russia/Ukraine war, but companies sat on the sidelines. Why invest in new production when profits soared on the supply shortages? 

Finally, however, idleness has turned to action. Oil and gas producers have begun investing again as much of Europe is weening itself off Russian gas. What’s more, this is not temporary. Even if the Russia/Ukraine war ended today, Europe will never again become dependent on Russian gas. This means strong demand for US gas going forward, which means sustained investment in drilling. Presently, US oil production is higher than ever, and natural gas production is closing in on its 2019 fracking driven peak.

Now, let’s examine the other “fuel”: food. Groceries began their rise during Covid-19 as supply chains were disrupted and food processors, especially meat, experienced rolling shutdowns of facilities. Food prices continued their rise in 2022. Much of this simply came from the concentrated market character of processed food, where a few big players could collude to drive up prices (profits). But, underlying factors were also in play, such as disruptions and uncertainty of global grain supply given the war between Russia and Ukraine, where both constitute nearly a third of global wheat exports, which then impacts bread and pasta prices.

Eggs are another staple of many people’s diets, and a food that often dramatically rises during energy crises. Chicken feed cost is connected to petroleum through fertilizer and diesel needed to grow it. Avian enclosures then use more fuel yet for heat. Most infamously, egg prices rocketed up by nearly 50% in the wake of the Yom Kippur war of 1973 that kicked of the 300% jump in the cost of oil that year. Similarly, the energy price spikes from the Russia/Ukraine war had the same impact in 2022, which saw egg prices jump up roughly 25%. As always, when the waters are chummed with energy price spikes, sharks come to feed, with some collusion and speculation further driving up prices. Yet, egg prices (like oil and gas) are also now falling and would be dropping faster still if not for Avian flu. But, that too will get sorted as the market corrects with greater supply.

In short, inflation is falling, and not just for non-core items. Therefore, the Federal Reserve would be well advised to back off on further hikes to the prime lending rate, which slows the economy and hurts working people.

Jeffrey Sommers is Professor of Political Economy & Public Policy at the University of Wisconsin-Milwaukee and Senior Fellow at their Institute of World Affairs.