MNI: Fed Has Room to Run on Price Expectations, Advisers Say

The Federal Reserve still has an anti-inflationary mindset and could act quickly if necessary after likely looking through price surges this year, current and former Fed advisors told MNI, though they all still saw ample room for medium-term inflation expectations to rise after a decade of downside misses.

Deeper structural pressures from globalization, new technology, sluggish wage growth and weakened unions mean officials should remain patient, said Laurence Ball, a former visiting scholar at the Fed and a consultant for the IMF, speaking after FOMC members lined up this week to mostly write off a spike in inflation as temporary, despite signs of unease among some current and former staffers.

The Fed's preferred Common Inflation Expectations index can move up "a lot more" from its most recent 2.01% reading, even to something approaching 3% over time, Ball said. The Fed could pivot to tackle any dangerous inflation jumps, he added.

"Some are looking for reasons to think inflation is going to take off when we have this long track record of the opposite problem," said Ball. "Having inflation expectations becoming de-anchored in the downward direction over the medium-term is still more of a risk."

INVERTED EXPECTATIONS

While some economists close to the central bank are beginning to fear the Fed may be risking a policy mistake, Cleveland Fed academic consultant Michael Weber took a similar tack to Ball, saying that recent short-term inflation expectation gains are "mainly due to the fact that ordinary people think of inflation as groceries or gas prices," which officials should look through.

Headline CPI has quickened to 4.2% in April from a year ago, but measures of survey-based longer-term price expectations like the Atlanta Fed's business survey show far less pressure from temporary supply disruptions, and the NY Fed's consumer surveys shows a rare inversion with near-term expectations above the medium--term.

Ball and Weber said policy makers should block out "noise" coming from supply issues because longer-term price surveys have not moved much relative to near-term expectations or historical data.

After April's prices data surprised to the upside, FOMC members this week insisted monetary stimulus will continue until there is a run of clear evidence their goals of pulling inflation 2% and regaining full employment are in close sight.

Governor Christopher Waller said Thursday that only months of 4% inflation would appear worrying, the Richmond Fed's Tom Barkin said firms are not resetting longer-term price views and Raphael Bostic of the Atlanta Fed said Wednesday the inflation jump does not need a policy response and that bouts of volatility around inflation will last through at least September.

For all the market talk of runaway inflation, 10-year Treasuries still yield less than 2%, and Charles Evans at the Chicago Fed has challenged inflation hawks to spell out exactly what scenario is so dangerous, while Mary Daly in San Francisco has said no one should give into fears of inflation from decades long past.

70s REDUX

Some Fed watchers say they are reminded uncomfortably of arguments made during the late 1960s and 1970s before uncontrolled double-digit wage and price gains.

Officials are likely going to discount inflation data through much of this year but not beyond that, said Jonathan Wright, a former member of the Fed Board's division of monetary affairs and current New York Fed adviser.

"Hawkish members of the FOMC could make the argument that back in the 70s one of the ways that the Fed got into the great inflation was they kept explaining inflation with special factors but that process took several years," he said.

"The Fed isn't going to pay too much attention to those high inflation numbers, and what we are all really looking for is what's going to happen to inflation in 2022," Wright said.

"If at the first sign of a little bit of overshooting, the Fed would actually start raising rates again, then the new framework would immediately lose credibility," said Weber, the Cleveland Fed consultant. "Their goal is to be purposefully behind the curve."