MNI INTERVIEW: Fed's Lags To Inflation Have Shortened - KC Fed

The Federal Reserve's expanded toolkit over the years to include forward guidance and balance sheet policy means there's a shorter lag in policy transmitting to inflation, Kansas City Fed senior economist Taeyoung Doh told MNI, adding he expects a continuing deceleration in inflation.

"The peak impact on inflation is actually likely to happen right now in the first half of this year," he said, noting a significant jump in a proxy measure of the fed funds rate in the first half of last year and estimating a one-year time lag.

Still, it is likely less than half of the Fed's overall tightening has flowed into inflation so far, Doh said in an interview.

Recent research from Doh and San Francisco Fed coauthor Andrew T. Foerster suggests there may have been an acceleration in the maximum effect on inflation following the Fed's broader use of balance sheet and forward-guidance tools in 2009, reducing the time between policy moves and their peak impact from three years to as little as 12 months.

"It is not fully reflected yet," he said. "This [inflation] deceleration that we've seen recently has been driven by commodity price fluctuation and a lot of that depends on external conditions and not monetary policy conditions."

UNEMPLOYMENT UNCERTAINTY

The research from Doh and Foerster uses a proxy federal funds rate that incorporates public and private borrowing rates and spreads to measure the monetary policy stance and shows that monetary policy has been substantially tighter than the federal funds rate indicates.

The proxy rate peaked in the cycle in November at 6.44% before easing to 6.16% in December, declining for the first time since May 2021, due to a slide in mortgage rates and because of a continued fall in longer-dated Treasury yields. It could dip again for the month of January despite expectations for another fed funds rate increase February 1, Doh said.

Fed officials have recently taken to citing the KC Fed research to suggest monetary policy lags could be shorter. Fed Vice Chair Lael Brainard Thursday said "it is likely that the full effect on demand, employment, and inflation of the cumulative tightening that is in the pipeline still lies ahead."

But Doh said there is no statistically significant evidence that the unemployment response to policy tightening has changed in recent years.

"That huge uncertainty is driven by the factor that in the previous tightening we had very gradual tightening but the unemployment rate didn't move up," he said. "This seemed to suggest a very muted response of unemployment today as policymakers continue to raise rates but there is great uncertainty."

So far the KC Fed economist is cautiously optimistic there's a narrow chance for a soft landing in which inflation moderates and real growth remains positive and unemployment stays low. (See: MNI INTERVIEW: Minneapolis Fed's Raffo Upbeat On Prices, Growth)

"So far I don't see any contradiction in the data flow compared to the study."

Source: San Francisco Fed