It’s easier to spot peak inflation from a historical perspective than it is to determine in real time.
What Is Peak Inflation?
Inflation that has reached its highest rate over a period is said to have reached its peak. After peaking, inflation slows down. Like predicting highs in the stock market, it’s difficult to time peak inflation. Investors and analysts tend to use the term when inflation is transitory or becomes persistently high, and consumer prices show few signs of easing.
Is It Difficult to Determine Peak Inflation?
One measure of inflation to monitor is the Consumer Price Index. The Federal Reserve’s preferred measure, though, is the Personal Consumption Expenditures Price Index. There may be specific items, such as housing and energy prices, within the indexes contributing to an acceleration in inflation, but it’s difficult to determine when such prices have reached their highs and consequently when inflation has peaked.
Peak Inflation Example: The Great Inflation
During the Great Inflation of 1965–1982, inflation was thought to have peaked in 1970, only to have reached a higher rate in 1974 after consumer prices tumbled for a brief period, and then reaching another peak in 1980, when the monthly CPI rate on an annual basis hit 14 percent.
The graph below shows how the Federal Reserve has reacted to higher rates in the CPI (red line) and PCE (blue) by setting monetary policy through its main tool, the Federal Funds Rate (green). As inflation remained persistently high, the Fed raised interest rates in a bid to keep consumer prices in check. As inflation peaked and then subsided, the central bank began to ease its monetary policy stance.
Peak inflation tends to indicate when the U.S. economy slips into recession.
Screenshot via Federal Reserve Bank of St. Louis
Historically, the Fed funds rate has been higher than the inflation rate, and one interpretation of the wide gap between interest rates and inflation during the 1980s and 90s is that higher rates have helped to keep inflation under control and prevented it from accelerating quickly.
The graph also shows that it’s easier to spot peak inflation from a historical perspective rather than in real time. The areas shaded in gray represent periods of recession. This suggests that the U.S. economy typically slips into recession when inflation peaks and the Fed takes aggressive monetary policy actions.
