MNI INTERVIEW:Infl Expctns Likely Hovering at 2%-Fed Economist

--Inflation Driven By Inflation Expectations "Difficult" To Prove

--Possible There Could Be Downshift in Consumers' Inflation Expectations

By Sara Haire

     WASHINGTON (MNI) - Concerns over the impact that inflation expectations

have on actual inflation have been ramped up by some economists recently as

expectation measures have converged closer to 2%, but in an interview with MNI,

Cleveland Fed senior vice president and research economist Edward Knotek said

that there could be a number of reasons why expectations have shifted and that

there is no proven consensus on whether inflation expectations drive actual

inflation--or vice-versa.

     Some economists have voiced concern after a few inflation expectation

measures have declined in the last few years, fearing inflation expectations

could "unanchor" if there are continued gradual interest rate increases before

inflation has been sustained at the Fed's 2% symmetric objective. At the same

time, a few other inflation measures have risen in recent months to eclipse the

2% threshold.

     As Knotek pointed out, most economists would believe that short-term rises

in inflation "would be somewhat tamped down by business cycle factors and/or

monetary policy aggressively responding to that, which would bring it back to

the long-run target."

     Knotek mused that shifts in the measures could either be from a removal of

bias from the data, or a "substantive downshift in trend from consumers

responding," which would be considered "even more nefarious." However, despite

these declines in some measures, inflation expectations appear to be inching

closer to intersecting at or above 2%.

     The minutes from the May 1-2 Federal Open Market Committee meeting affirmed

that that there would not be an overreaction to inflation data modestly

overshooting the 2% target and that it instead "could be helpful in anchoring

longer-run inflation expectations."

--INFLATION EXPECTATIONS INTERSECT

     Fears about inflation "unanchoring," should be put on the back-burner for

now given survey, market, and model-based measures are hovering at the 2% trend,

if not above it.

     The Michigan Survey of Consumer Sentiment inflation expectations "has been

coming down," Knotek said, however expectations still remain above the 2% trend,

while business inflation expectations, as measured by the Atlanta Federal

Reserve Bank, found expectations for the 5-10 year horizon remain below levels

seen five years ago.

     Market-based measures of inflation, such as the five and ten-year breakeven

inflation rates, have recently risen, hitting slightly above 2%, but still have

not broken the highs seen in 2014.

     Conversely, the Cleveland Federal Reserve Bank publishes a model for the

10-year inflation expectation that recently reached a high since April 2010,

climbing to 2.09%. This model uses Treasury yields, inflation data, inflation

swaps, and survey-based measures of inflation to find what the expected

inflation rate will be.

     Careful to not be reactionary, the Survey of Professional Forecasters has

shown in the last five years that 10-year PCE inflation expectations have been

relatively stable, hovering at 2% with little variation in the data.

--CHICKEN OR EGG

     Recent research suggests that inflation data could be shaped by the

expectations for where inflation is headed, suggesting that the need to keep

expectations at around 2% is pivotal to make sure inflation is maintained at the

FOMC's symmetric objective in the near-term.

     However, the question of whether inflation drives inflation expectations or

vice versa is "a very difficult issue to disentangle" with no real right answer

yet, Knotek explained.

     Knotek noted that developments in the economy force models to evolve and is

likely to shift the way in which inflation expectations are measured in the

future, which could eventually account for possible downshifts in consumers'

expectations or a removal of an upward bias. 

--MNI Washington Bureau; +1 212-800-8517; email: sara.haire@marketnews.com

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