MNI INTERVIEW: Fed Inflation View Still Too Benign- Blanchard

The Federal Reserve remains overly optimistic that price measures will return toward target over 2022, though a temporary dip in inflation in coming months may tempt some observers to declare a premature victory, former International Monetary Fund chief economist Olivier Blanchard told MNI.

“When you have momentum in inflation it may be hard to stop and they may be forced to do much more than they currently expect,” said Blanchard, now a senior fellow at the Peterson Institute for International Economics, in an interview.

Robust savings and a hot job market are likely to keep overall inflation above levels Fed officials foresee, Blanchard said. The Fed’s year-end forecast for the personal consumption expenditures index was 2.6% at the December meeting, up from 2.2% in September.

“There’s still this enormous amount of excess savings that really hasn’t been spent,” Blanchard said. “Demand could be quite strong and unemployment could become very low.”

A potential easing of supply chain bottlenecks during the first half of the year could provide false comfort to policymakers, he warned.

Consumer prices soared far beyond Fed officials’ and market expectations over the course of 2021, surging 6.8% in the year to November. The Fed’s preferred PCE measure jumped 5.7% over the same period.

WAGE-PRICE INTERACTION

“The thing I worry about is the wage-price interaction, and with a tight labor market which we clearly have, which could be tighter if I’m right on demand, and an administration that is clearly pro labor,” said Blanchard. “That might well put pressure on wages. That gets into prices and people tell me well prices won’t go up even if wages go up – I don’t believe that for a second.”

Fed officials have tried to pivot fairly quickly recently in their messaging on inflation, moving away from the argument that price increases were “largely transitory” and toward acknowledging that pressures were more widespread than previously thought.

Policymakers are now penciling in three rate hikes this year after having been doubtful about any at all as recently as September. Yet Blanchard is among those who worry the about-face may be too little too late.

“I suspect that what we’re going to see over the next six months is better numbers on inflation,” he said. “Some people are going to claim victory, and I hope they are right, but they might be wrong because I think people have realized that wages can go up quite as much as prices – the prices they perceive.”

POWELL'S CHALLENGE

While underlying inflation remains relatively subdued, consumers will react to jumps in headline prices, he argued.

“Inflation is probably less bad than people perceive but they put the weight exactly on what the Fed doesn’t care about. The Fed cares about core, people care about non-core – gasoline, food,” Blanchard said.

But the former IMF economist downplayed the possibility that the Fed, which said in December that it would speed up its tapering of bond purchases, might actively deploy its balance sheet as a tightening tool.

“I believe that at this stage the balance sheet part is very much PR. I think what really makes a difference in the end is the policy rate," he said.

The Fed will have to tread a fine line between the need to fend off elevated inflation and jittery asset markets that seem priced for perfection, according to Blanchard.

“That’s Jay’s main challenge at this point, which is to move the leaves in markets slowly enough that they don’t panic and fast enough that he gets where he wants to be,” he said referring to Chair Powell. “I think he’ll do as good a job as can be done but it’s not exactly an easy job to do.”