Even with higher interest rates and cost increases, inflation still proves hard to vanquish

McDonald's Corp. calls them "strategic menu price increases," and their impact is visible on menu boards across the chain, where a Big Mac, medium fries and soft drink now sells for as much as $18. Surprisingly, people are paying up, at least for now, as the Chicago-based restaurant company dutifully noted in its most recent earnings report last week.

So it goes across much of the economy, which has shown surprising strength despite the U.S. Federal Reserve's historic effort to tamp it down. Consumers continue to spend, spend, spend, prompting Fed Chair Jerome Powell to ruefully cite an ongoing "surge" of consumer spending in his latest public remarks.

While the Fed last week decided to leave short-term interest rates unchanged, at a range of 5.25 percent to 5.5 percent, Powell stressed that inflation is still too high and more rate hikes may be needed to achieve the central bank's 2 percent goal. (Overall prices rose 3.4 percent in the 12 months ending in September.) The financial markets took Powell's relatively dovish tone as a signal that an additional hike may not come at the Fed's Dec. 12-13 policy meeting, as some previously expected.

Higher interest rates are causing real pain and we think the Fed was right to leave them alone this time. Nonetheless, we've long cheered on Powell's efforts to whip inflation for a simple reason: Runaway price increases are much worse in the long run than the painful and disruptive effects of higher interest rates.

The Fed has succeeded in sending rates considerably higher, making it much more expensive to borrow. Those higher rates already have chilled the hot residential real estate market by raising the cost of mortgage loans. Keeping those higher rates in place will eventually put a lid on wage hikes and reduce demand for everything from clothing to restaurant meals, eventually tamping down inflation.

When can the Fed finally relax? Soon, we hope, but when is still difficult to predict. Plenty of economists have looked foolish doing so, given how the COVID-19 pandemic scrambled well-understood economic relationships, making forecasting an even bigger guessing game than usual.

Along with the difficulty of predicting how a pandemic would affect commerce and consumer behavior, fiscal policy complicated the outlook. The Trump and Biden administrations pumped an excessive $4.6 trillion into the economy in pandemic-related stimulus, while Biden then added more spending for clean energy and infrastructure projects. That was a ton of taxpayer money goosing the economy, with some of it still to be paid out.

With the pandemic shutting down travel in early 2020 and supply disruptions creating shortages of sought-after goods, Americans piled up savings. Around the middle of 2021, consumers launched a spending spree that mostly continues today, despite higher prices and interest rates. In recent earnings reports, corporate leaders have noted the resilience of U.S. consumers in the face of price increases.

Finally, stresses are beginning to show up in household balance sheets, which could signal that all those Fed rate increases are starting to have the intended effect.

The savings rate has fallen, as consumers shopped their way through their bank accounts. Nearly one-third say they have less money saved for an emergency than they did at the start of the year, according to a recent Bankrate survey, and fewer than 1 in 5 respondents have added anything to their rainy-day funds in 2023.

And while pay increases have outpaced inflation for much of the year, income growth is starting to slow. Those with lower credit scores especially are feeling the pressure, as reflected in a rising number of people at least 60 days late on car payments.

Recent data show that the prices of goods such as cars, furniture and appliances are starting to fall, but the prices of services remain exceptionally high.

The Fed needs to watch those prices closely, as services are labor-intensive and therefore more sensitive to businesses passing on their higher labor costs by raising prices. One prominent example: The prices of restaurant meals rose 0.4 percent from August to September and are now 5.8 percent more expensive than a year ago.

In Chicago, those prices are likely to keep going up. The city just raised the minimum wage for tipped workers, and it is considering imposing on businesses onerous and costly new requirements for paid leave, not to mention a huge increase in real estate transfer taxes. Does no one at City Hall recognize that businesses will not be able to simply absorb the higher costs imposed by a mayoral administration determined to soak its most productive citizens?

As Powell said, the process of getting inflation down to a manageable rate on a sustainable basis has "a long way to go." The Fed needs to stay with it, even as less responsible public officials make the job harder.

A version of this editorial originally appeared in the Chicago Tribune.