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July’s income and spending data showed steady income growth and resilient consumption, while sticky 3% inflation highlights the Fed’s challenge of reaching its 2% target while avoiding a recession.

What Caught Our Eyes This Week

How Can We Get Back to 2% Inflation—Without a Recession?

Friday’s Personal Income and Outlays report for July was solid. It showed that incomes are still growing handily and that consumption is not falling off a cliff as some feared. On the other hand, it reminded us that inflation is sticky in the 3% range—notably above the Fed’s stated 2% target. So how do we kill that pesky “last mile”? The fastest way would be a recession, which is fun for no one and a path the Fed does not appear willing to take. Structural disinflation in a healthy economy is rare, but it has occurred. We look to the 1990s and that decade’s tech-driven productivity boom as an interesting corollary (although we likely won’t have the tailwinds of globalization and fiscal restraint). Looking forward, here is the non-recession path back to 2% as we see it:

  1. Any tariff inflation does indeed turn out to be transitory. Low goods inflation is an important part of the arithmetic of 2%, providing an offset to services inflation, which tends to run hotter.
  2. Housing inflation continues to fall. Over the longer term, the question of undersupply looms, but over the short and intermediate term, this trend appears intact thanks to softening rents.
  3. Productivity gains keep a lid on wages and services inflation (this is where AI would come in). Businesses that are getting more bang for their buck would allow wages to sustainably run above overall inflation, limiting the risk of a “wage-price spiral.”

Year-Over-Year Core PCE Inflation

CHART OF THE WEEK: Source: Cerity Partners, FRED, 08/29/2025 (Figures are seasonally adjusted)

Past performance does not guarantee future results.

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