How long will it take for US inflation to return to 2%? Cleveland Fed economist: If the economy does not go into recession, it will take another 3 years

The "last mile" of inflation resistance is a long journey, and the time required may exceed market expectations.

According to media reports on Wednesday, Randal Verbrugge, senior economist at the Federal Reserve Bank of Cleveland, said that due to the intrinsic nature of inflation, reaching the 2% target may take several years.

Verbrugge's model shows:

By the second quarter of 2025, the inflation rate will still be above the target, reaching 2.7%; by mid-2027, the inflation rate will be close to but still slightly above 2%.

When explaining why the "last half mile" of inflation is so stubborn, Verbrugge pointed out:

The three main forces driving inflation are: economic recession, economic overheating, and supply chain pressures. In the absence of these external factors, inflation typically has a persistent "intrinsic nature," and falling back to 2% without external forces pushing it will be slow.

This Friday, the Federal Reserve will release the "most favored" core indicator - the core PCE index. The consensus among top analysts reflecting the blue-chip economic indicators so far this year is that the PCE inflation rate will approach 2% in 2025, much earlier than Verbrugge's model predicts. However, Powell admitted earlier this month that bringing the inflation rate down to 2% may take longer.

Verbrugge explained why companies may continue to raise prices even when they expect inflation to decline:

The intrinsic persistence of inflation is based on people's expectations of the future and the way prices are set in the economy.

Since April 2023, inflation has been declining relatively rapidly, but because inflation is still positive, most adjustments are also positive, so the question is how much more will it rise?

Wages are one part of it, if companies suddenly have to pay higher wages, it will squeeze profit margins, and companies may try to raise prices to avoid compressed profits.

Therefore, Verbrugge believes that unless there are external forces or unconventional intrinsic forces driving it, inflation will not quickly return to 2%, but will slowly drag its feet down.

Historical experience also proves this to be true, especially from 2012 to 2019, the 12-month trimmed mean of PCE inflation rate only changed by half a percentage point, which took about six years. The trimmed mean is another way to observe the core inflation rate, excluding the components with the fastest and slowest monthly growth.

Overall, Verbrugge's model implies that if supply chain improvements no longer drive inflation down, the only downward pressure that can be exerted is economic recession. And if there is no economic recession, then patience is needed, as inflation falling back will take at least 3 years.

In addition, Verbrugge added that economic recession will help companies make decisions. They can gradually raise prices or wages over time, rather than increasing by 4% or 3.5% this year