Fed Faces Credibility Test as Inflation Remains Above Target

The US inflation rate has been above the Fed's 2% target for over five years. In August, year-over-year inflation was 3.4%, while the core rate was 2.4%. The auto insurance component fell 5.1% year-over-year, which would have pushed both rates up by roughly 0.2 percentage points.

The Fed's credibility is being tested as it considers raising interest rates to combat inflation. However, Dean Baker, a senior economist at the Center for Economic and Policy Research, argues that a rate hike will have little impact on bringing down inflation in the short term.

Baker notes that wage growth has slowed significantly, from over 4% in 2023-2024 to just 3.1% in August. He also points out that there is no evidence of inflation accelerating when wage growth is falling. Furthermore, Baker believes that a productivity boom could potentially bring down inflation below the 2% target.