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Cleveland Fed Model Predicts Inflation Will Take Years to Reach 2% Target

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Inflation in the U.S. is expected to remain elevated for at least three more years, according to a new report from the Cleveland Federal Reserve Bank. The pandemic-era shocks that led to high inflation, such as supply chain disruptions and heightened consumer demand, have largely subsided. However, there are still underlying factors within the economy that are fueling price pressures. The report suggests that inflation may not return to pre-pandemic levels until mid-2027 at the earliest.

Economist Randal Verbrugge distinguishes between extrinsic and intrinsic sources of inflation. Extrinsic factors are external shocks like production costs or the labor market, while intrinsic factors include wage and price decisions as well as inflation expectations. The resolution of supply chain disruptions contributed to the decrease in inflation last year, but this progress seems to have reached its limit. Moving forward, inflation is expected to be driven by intrinsic dynamics, such as wage growth and price adjustments by corporations.

The high inflation rates in the U.S. have put significant financial strain on households, particularly low-income families who spend a larger portion of their income on necessities like food and shelter. Grocery prices have increased by more than 21% since the beginning of 2021, while shelter costs have risen by 18.37%. Energy prices have also seen a substantial 38.4% hike. These price hikes have made it challenging for many Americans to make ends meet and save money.

To combat inflation, the Federal Reserve raised interest rates in 2022 and 2023 to the highest level in over two decades. The goal was to slow down the economy and ultimately control inflation. However, policymakers are now contemplating when to start reducing interest rates amid concerns that progress on inflation has stalled. Despite some officials suggesting that borrowing costs should remain high, the central bank is cautious and not rushing to make any changes until inflation is under control.

Several Fed officials have expressed the view that borrowing costs should stay elevated for a longer period as inflation remains at abnormal levels. New York Fed President John Williams mentioned in a recent interview with Reuters that it may take some time before the Fed gains enough confidence in the progress towards the 2% inflation goal. The central bank officials are closely monitoring the situation and will adjust their policies accordingly to ensure that inflation is brought back under control.

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