(The Center Square) – If current inflation and personal savings trends continue, inflation will return to a 2% annual rate next year, according to an economist with the Federal Reserve Bank of St. Louis.
In a post on the St. Louis Fed’s “On the Economy Blog,” Fernando Martin, an economist and senior economic policy advisor, examined whether high inflation is nearing an end or if it will settle in at rates higher than before the COVID-19 pandemic.
In an effort to stop high inflation, the Federal Reserve began a series of rapid and continual increases in interest rates to slow consumer consumption. Consumer spending followed three rounds of direct federal financial assistance to individuals and households.
“Accumulated excess personal savings peaked at $2.2 trillion in August 2021 and have been declining ever since,” Martin wrote. “However, they still stood at over $600 billion as of August 2023. … despite the curbing incentives provided by higher interest rates, households on average have the capacity to continue consuming above trend in real terms and more than make up for pandemic-related privations.”
Martin’s research found excess savings jumped in April 2020 with the Coronavirus Aid, Relief and Economic Security (CARES) Act and inflation accelerated several months later. Inflation went above the Fed’s 2% target rate in March 2021, excess savings peaked in August 2021 and inflation peaked in September 2022.
“Both excess savings and excess inflation have trended down steadily since reaching their peaks, inflation a bit faster than savings, likely due to tighter monetary policy,” Martin wrote. “If these recent trends were to persist, both excesses will have vanished by the end of the first half of 2024. That is, by June 2024 accumulated excess savings will have been depleted, while inflation will have fallen to 2% annually.”
However, Martin identified three risks to a return to low inflation.
“First, energy prices have again surged, with oil currently trading at prices similar to those in late 2022,” Martin wrote. “This reversal will likely arrest the momentum in headline inflation and may adversely affect inflation expectations should this rally persist.”
Second, inflation in services remains “stubbornly high.” Third, a rising federal deficit could keep inflation high. Estimates put the federal deficit at $1.7 trillion, approximately $300 billion more than 2022, according to the Congressional Budget Office’s September budget review.
“Consequently, debt in the hands of the public increased by about $2.2 trillion in 2023,” Martin wrote. “The debt is expected to continue growing over the next decade and beyond. An outsized increase in government liabilities, particularly when used to support direct transfers to individuals as was the case during the pandemic, may lead to a sharp rise in prices. Though the effects of pandemic expenditures are dying out, as evidenced by the slow but steady decline in excess savings, persistent large deficits may again put upward pressure on future inflation.”