MNI EXCLUSIVE: Fed Fears Lagging Prices as Recession Deepens

By Jean Yung and Pedro Nicolaci da Costa

     WASHINGTON (MNI) - Fears over disinflationary forces are growing within the

Federal Reserve as the economy faces a deeper hole than policymakers had

foreseen, according to interviews with current and former officials. 

     Top Fed brass have maintained they expect monetary policy to keep the

economy on track to reach their 2% inflation target, which was undershot during

most of the recovery from the Great Recession.

     Privately, former and current officials tell MNI that the downsides from

such a severe shock to the economy outweigh the inflation risk, either from

aggressive monetary and fiscal policy or from supply-side shocks from Covid-19.

A deep slowdown could also destabilize business and household finances for a

long time.

     "If lots of small businesses keep closing permanently and the employment

situation doesn't recover, it starts to feel more and more like the Great

Depression," Andrew Levin, former special adviser to the Fed chair under Janet

Yellen, said in an interview. 

     "That is a situation where inflation could end up way below the Fed's

target for a long time." 

     --NOT-GREAT EXPECTATIONS

     At worst, a self-reinforcing spiral of price falls and defaults could cause

deflation to become entrenched. Monetary policy, with rates already at zero, is

ill-equipped to counter that scenario.

     The Fed's preferred inflation measure has softened considerably in recent

months, a rare event that tends to set off alarm bells among central bankers.

Core PCE inflation slowed to 1.0% in May from 1.8% earlier in the year, the

lowest in nearly a decade. 

     The Fed is especially worried about signs that inflation expectations are

already drifting lower, current and former officials told MNI. 

     Fed Gov. Lael Brainard offered the first public hints from the Federal Open

Market Committee that it is taking seriously the risk of a deeper disinflation

in a keynote speech this week.

     "With inflation coming in below its 2% objective for many years, the risk

that inflation expectations could drift lower complicates the task of monetary

policy," Brainard said.

     --ATLANTA FADE

     Dallas Fed President Robert Kaplan also told MNI earlier this month that

slack in the economy is boosting disinflationary pressures, even as supply chain

issues in meat and food industries have caused a rise in those prices.

     New evidence from the Fed's real-time data gathering efforts suggest there

is already reason for concern. Inflation expectations on the part of businesses,

a better harbinger of future price trends than consumer surveys, have fallen

dramatically since March, according to the Atlanta Fed.

     Year-ahead business inflation expectations for firms in the Atlanta

district have fallen from as high as 2.3% in 2018-2019 to 1.4% in April, the

lowest on record for its survey going back to 2011. Expectations have stayed

below 1.7% over four straight months.

     "We saw this low level of inflation expectations a couple times in 2016-17

but not anything where inflation expectations stayed this low for this long,"

Atlanta Fed policy adviser Brent Meyer told MNI. "Firms on balance see the

Covid-19 shock as a demand shock, and that's a restraining force for inflation."

     --NO IMPACT

     Even firms that have experienced a simultaneous hit to sales and to supply

chains on average expect to have to lower prices over the next six months, Meyer

said.

     Meyer takes comfort in the fact that firms haven't yet shifted their

longer-run inflation expectations, which "remain reasonably well anchored."

     "If we saw a really tight correlation between businesses lowering both long

run and short run expectations, that would give me quite a bit of concern," he

said.

     Levin worries the Fed's intention to deal with such a problem by promising

to keep interest rates low for a long time will have little impact. 

     Markets already largely expect this so the announcement, which the

Dartmouth College economist said could come as early as this month's meeting,

would offer "no additional stimulus whatsoever."

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

--MNI Washington Bureau; +1 202 371 2121; email: pedro.dacosta@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]