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MNI INTERVIEW: Expectations ‘Source Of Concern’-Fed’s Knotek

Cleveland Fed research director sees gradual decline in inflation to 3.5-4% by year end.

(MNI) WASHINGTON

High inflation expectations for consumers and businesses are a source of concern for an economy where price pressures are set to abate all too gradually, Cleveland Fed research director Edward Knotek told MNI.

He said the Cleveland Fed’s own surveys of individuals and businesses point to inflation expectations of around 6% over a one-year horizon.

“They really suggest that people expect inflation to be pretty high over the next year. Not out of control but still pretty high,” Knotek, who as part of his role advises President Loretta Mester on monetary policy and attends FOMC meetings, told MNI’s FedSpeak podcast.

These are “consumers and firms, who are the price setters and wage setters – the demand side. The fact that those inflation expectations are high is a cause for some concern.”

He said a key lesson for policymakers from the Great Inflation of the 1960s and 1970s is that “the longer that inflation remains high, the more likely it is that high inflation is going to get entrenched in the economy, it’s going to become harder to bring down.”

NO SPIRAL

At the same time, his research indicates a wage-price spiral is not yet under way, said Knotek, who also leads the regional Fed’s Center for Inflation Research.

“There’s not that much evidence of one of these expectational wage-price spirals at play,” he said.

Still, he added: “I don’t think we want to rest on our laurels and suggest that can’t happen. The quicker you get inflation down, the sooner you can help re-anchor those expectations at a level that would be appropriate.”

WAR OF THE MODELS

Knotek said there was unusual uncertainty about the likely path of inflation, with some models suggesting it might come down quickly while others point to longer-lasting economic shifts, including a super tight labor market, as making price pressures more entrenched.

“My modal forecast is that we will see some inflation relief. Personally I’m in the 3.5-4% camp” for year-end 2023 inflation, he said, citing modest upside risks. The Fed’s December central tendency forecast range for the PCE at the end of this year was 2.9% to 3.5%.

He pointed to recent research from his colleagues at the Cleveland Fed hinting at a “more fundamental persistence” in the inflation process.

“They estimate inflation is quite persistent, and given where you’re starting that suggests it could take some time for inflation to come back down,” said Knotek.

Fed Chair Jerome Powell delivered a hawkish message in testimony this week, corroborating a recent market repricing of interest rate peak expectations up toward around 5.5%.

(See MNI INTERVIEW: Fed Will Hike Rates To 6% Or More-Gorodnichenko)

LABOR MARKET EASING?

Knotek said there are signs the labor market is cooling despite the outsized jump in payroll gains for January.

“The labor market doesn’t feel quite as tight as it did a year ago, there seems to be less froth. Wage growth is high but it’s come down a little bit,” he said.

Still, there is more work to be done in bringing employment conditions into the sort of better balance that will help tame inflation.

“There’s still evidence that we need to see more moderation in the labor market, more moderation in labor demand or some improvements in labor supply to get the labor market to a better place in order to have less inflationary pressure in the economy,” he said.

“This certainly ties into the services side of the economy where there are concerns about inflationary pressures there being quite persistent because of their connection to the tightness of the labor market.”

MNI Washington Bureau | +1 202 371 2121 | pedro.dacosta@marketnews.com
MNI Washington Bureau | +1 202 371 2121 | pedro.dacosta@marketnews.com

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