What caused the decline in inflation in Europe and the United States? Is further interest rate hikes really necessary?
Recently, inflation in Europe and the United States has continued to cool down. In June, the US CPI dropped from 7% a year ago to 3%, while the Eurozone CPI fell to 5.5%, the lowest level in nearly 18 months.
Nick Timiraos, a Wall Street Journal journalist known as the &#34;mouthpiece of the Federal Reserve&#34; and the &#34;new Federal Reserve News Agency,&#34; pointed out in a recent article that the &#34;good news&#34; about inflation has sparked a debate - whether the decline in inflation is due to the easing of supply constraints or the credit of the Federal Reserve's interest rate hikes.
Two opposing camps hold different views. One side believes that the decline in inflation is driven by the easing of supply constraints, while the other side believes that it is the central bank's interest rate hikes that have played a leading role.
The answer to this question is related to the future direction of inflation and interest rates. The Federal Reserve and the European Central Bank raised interest rates to the highest level in 22 years last week and opened the door for further rate hikes.
Timiraos believes that if the progress of inflation so far is not caused by the rise in interest rates, it indicates that the central bank may lower interest rates before the painful economic recession arrives.
<h2>Easing of supply constraints or interest rate hikes?</h2>
In June, the inflation rates in the United States and the Eurozone dropped to 3% and 5.5% respectively, while the unemployment rate remained stable. The possibility of an &#34;economic soft landing&#34; has increased. What role did the central banks play in this?
Timiraos pointed out that usually, central banks suppress demand for goods, services, and labor through interest rate hikes, which in turn leads to an increase in the unemployment rate, putting downward pressure on prices and wages. Did the actions of the Federal Reserve and the European Central Bank in raising interest rates contribute to the decline in inflation?
One camp believes that inflation is mainly caused by supply constraints, and supply constraints will naturally ease over time. For example, during World War II, there was a shortage of goods in the United States, but it gradually eased after the war. The ripple effect created an illusion of widespread and prolonged price increases.
Take the automobile market as an example. Two years ago, sellers couldn't meet the suppressed demand, leading to a significant price increase, which in turn drove up the prices of car repairs and insurance.
The main reason for the recent decline in inflation is the easing of supply disruptions, not interest rate hikes, because interest rate hikes affect the labor market, but currently, the unemployment rate remains low.
The other camp holds a different opinion, emphasizing the effectiveness of monetary policy. Interest rate hikes slow down the demand for goods, services, and labor, thereby alleviating pressure on the supply chain and easing price pressures.
Interest rates also affect behavior, and the automobile market is a good example. Increasing interest rates raise monthly payments, naturally suppressing demand and depriving sellers of pricing power. Since March, US banks have rejected more car loan applications.
Karen Dynan, an economist at Harvard University, believes that if it weren't for the Federal Reserve's interest rate hikes, the inflation rate would definitely be higher and even continue to rise.
<h2>Is further interest rate hikes necessary?</h2>
What do central bank officials think? Christine Lagarde, the President of the European Central Bank, said last Thursday that interest rate hikes have been transmitted to the financial system, but not much in the overall economy.
Federal Reserve Chairman Powell believes that rate hikes have had the desired effect and will play an important role in the future, especially in reducing the prices of labor-intensive services.
Timiraos points out that a report released by the German insurance giant Allianz states that the US inflation rate has been influenced by three different forces since the second quarter of 2022.
<blockquote>
Consumer spending, a strong labor market, and government spending have increased inflationary pressures by 4 percentage points, while the easing of supply chain disruptions has reduced it by 5 percentage points. The actions of the Federal Reserve have further reduced it by 5 percentage points. The net effect is a decrease in the inflation rate by 6 percentage points, whereas without the actions of the Federal Reserve, the inflation rate would have only decreased by 1 percentage point.
</blockquote>
Some economists have pointed out that monetary policy has also had an impact on the labor market, but this is reflected in a decrease in job vacancy rates rather than an increase in unemployment rates. Stefan Gerlach, former Deputy Governor of the Central Bank of Ireland, states that labor markets on both sides of the Atlantic are moving towards normalcy, which reflects the impact of rising interest rates.
The debate about the effectiveness of rate hikes also relates to whether central banks in various countries need to further raise interest rates. Gerlach believes:
<blockquote>
As interest rates rise and dampen demand, inflation will continue to decline. I am concerned that central banks have already done too much.
</blockquote>

"Is the decrease in inflation due to the easing of supply constraints or the credit of the Federal Reserve raising interest rates?"

"New Fed News Agency": This "Key Debate on Inflation" will determine whether central banks in Europe and the United States will raise interest rates.