What the Fed’s confidence in inflation hides
As the Fed says and does according to the Wall Street Journal
The Federal Reserve remains true to its history. The factors that pushed annual base inflation to a nearly 30-year high of 3.8% in May are largely "transient," he said Wednesday.
President Jerome Powell reiterated the point several times in his press conference: "Our expectation is that these high inflation readings … will begin to decline." The spike in used car prices will reverse as the timber price has already done, he said. Fed officials expect inflation to slow from 3.4% at the end of this year to 2.1% by the end of next year and to 2.2% by the end of 2023. The last two figures are each up by just a tenth of a percentage point from their March forecast – writes the WSJ .
But under the surface, some anxiety is creeping up. As of March, only five of the 18 participants on the Federal Open Market Committee thought inflation risks were weighted upwards. By June, this had risen to 13. In other words, a solid majority of Fed officials think inflation is more likely to turn out higher rather than lower than expected.
These shifting risks have found their way into rate officials' views. The median projection is now for a half percentage point rate hike by the end of 2023, compared to March's expectation of no change. Why are officials more in a hurry to raise rates now than in March, given how little their forecasts have changed? Mr. Powell said it was a question of trust. The Fed has set two conditions for raising interest rates: sustainable inflation at 2% and expected moderately above, and full employment. Many officials "are more comfortable that the economic conditions in [their] forward guidance will be met sooner than previously expected," he said. "And that would be a welcome development."
That said, it appears that their confidence in achieving the inflation target has increased more than their confidence in achieving the full employment target. Indeed, taken at face value, the inflation target may have already been achieved. Inflation is now above 2% and is expected to be moderately above for the next few years.
The problem is that this has not happened as predicted by a new policy framework presented last year. As inflation was below its 2% target, the Fed wanted inflation to correct a little above 2% so that over time it averaged 2%. To achieve this, he would let the economy overheat, pushing unemployment to pre-pandemic levels below 4%. This would push inflation a little above 2% for a while, a process that was assumed to take several years.
Instead, inflation has shot up as a result of the collision between high demand and tight supply, which serves to hold back job growth. This type of inflation is an idiosyncratic supply shock of the kind central banks have long fought against, Powell said.
As long as this increase is truly transitory, the Fed should be fine. And on this, the Fed has an important ally: the bond market, which thinks inflation is about to fall. But if these supply shocks push up public inflation expectations, which tend to be self-fulfilling, the Fed has a problem. It could no longer stick to its plan of waiting for full employment to return before tightening monetary policy. While Mr. Powell said the rise in expectations has not yet reached worrying levels, "we do not in any way rule out the possibility." And in that case, he said, “we wouldn't hesitate to use our tools to tackle it. Price stability is half of our mandate ”.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/fed-inflazione-cosa-dice/ on Sun, 27 Jun 2021 06:00:32 +0000.