MNI INTERVIEW: Chicago Fed Economist Sees Low Inflation Decade

A depressed U.S. labor market that keeps millions of workers underemployed will likely keep a lid on inflation for years to come, Federal Reserve Bank of Chicago senior economist Leonardo Melosi told MNI, a signal that the Fed remains focused on the threat of sluggish prices rather than a potential surge in inflation.

"This is going to be a decade in which wages and inflationary pressures are likely to be moderate," he said in an interview, citing his new research on job market slack that seeks to resolve the low-inflation puzzle that stumped policymakers during the last economic recovery.

Melosi's comments run counter to growing fears on Wall Street that a combination of strong monetary and fiscal responses to the pandemic-induced economic slump may actually generate a long-elusive burst of inflation.

The Fed's preferred measure of inflation, the personal consumption expenditures price index, rose just 1.1% in November, and recent deterioration in the growth outlook due to a winter resurgence in Covid cases portends further erosion.

"I don't understand why markets see inflation around every corner," Melosi said.

'BAD JOBS, LOW INFLATION'

His work focuses on underemployed workers who are not fully using their training or skills in the jobs they find, such as an engineer who was no longer able to find work after the Great Recession and ended up working in low-wage services, such as driver for a ride-sharing service.

"They find a job but it's not a job that fits their skills. And when a worker is in a bad job they have lower bargaining power," Melosi said, adding that the process is self-reinforcing: "Firms understand labor costs in the future are going to be low."

"Labor market slack is a multidimensional object -- we study this particular dimension which is the degree of labor misallocation," he said. "I don't see why this type of slack would be removed going forward."

Other researchers have found some 30% of the workforce was underemployed even before the pandemic. "I'm talking about a large chunk of workers," he said.

MODERATE INFLATION BOOST

As for the risk that a large fiscal stimulus will generate inflation, earlier research by Melosi suggests otherwise. "The strategy results in only moderate levels of inflation by separating long-run fiscal sustainability from a short-run policy intervention," he said.

In a paper entitled "Monetary and Fiscal Policies in Times of Large Debt: Unity is Strength," Melosi studied the implications of greater coordination between fiscal and monetary policy to generate a sustainable recovery from a shock like the coronavirus pandemic.

"The coordinated strategy enhances the efficacy of the fiscal stimulus planned in response to the Covid-19 pandemic and allows the Federal Reserve to correct a prolonged period of below-target inflation," he said.

The Fed has signaled it will be willing to tolerate some overshoot of its 2% inflation target, a way to make up for past misses and maintain the credibility of the central bank's commitment.

That move, along with the prospect of even more robust fiscal support now that Joe Biden's presidential win has been followed by two victories in Georgia that ensure Democratic control of the Senate, is reinforcing investors' medium-term inflation concerns.