Is the Fed behind the curve?

Monetary policymakers around the world are beginning, cautiously, to edge off the tight-money policies they imposed in an effort to cool inflation. Most important, the European Central Bank just cut the interest rates it controls by a quarter of a percentage point — a small number in itself but a signal of future normalization. And the ECB is a major player, setting policy for an economy around four-fifths as large as America’s.

But few people expect the Federal Reserve, which will hold a policy meeting next week, to follow suit. And that poses a puzzle. By the numbers, the case for rate cuts in America and Europe is almost identical. So either the Fed or the ECB is getting it wrong.

I think the ECB is right, and the Fed is wrong. Why?

First, the case for declaring inflation yesterday’s problem is equally strong on both sides of the Atlantic.

This point can be obscured by the fact that we measure consumer prices somewhat differently. Normally the Bureau of Labor Statistics releases its own version of Europe’s Harmonized Index of Consumer Prices, but the BLS is, at an inconvenient moment, having some kind of technical difficulties. The big difference between Europe’s measure and ours is that theirs doesn’t include “owner’s equivalent rent,” which is most of the shelter cost component of the consumer price index. So we can get a more or less apples-to-apples comparison by using a number the BLS is still releasing, consumer prices excluding shelter.

U.S. inflation has generally led inflation in Europe, both rising and falling sooner, but both cumulative inflation since 2019 and current inflation are similar — maybe somewhat above the long-run target, but central banks are supposed to get ahead of the curve. It’s hard to see any clear reason the Fed and the ECB should be following different paths now.

But who’s right? So far the U.S. economy has remained remarkably strong despite high interest rates. But there are signs of softening in various data. Notably, the ratio of unfilled job openings to the number of unemployed, which was widely cited as evidence of an overheated economy, is now all the way back to its prepandemic level and may be trending lower.

Central banks are supposed to get ahead of the curve. And it looks to me as if the ECB is doing that, but the Fed isn’t.

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