MNI INTERVIEW: High Inflation Easier To Tackle-SF Fed's Curdia

Rising U.S. inflation is so far a healthy sign of stronger growth prospects, and if expectations were to become excessive monetary authorities would find it easier to clamp down than when faced with price undershoots, San Francisco Fed Economist Vasco Curdia told MNI.

The increase in expectations to multi-year highs by some measures is in line with the Fed's framework shift last year signaling a desire to modestly overshoot the central bank's 2% inflation goal to make up for past misses, Curdia said in an interview.

"In the last downturn, inflation took a long time to recover--in fact it never fully recovered. In that sense, we've come from a long period in which inflation has been undershooting what would be the objective," he said.

The Fed's favored inflation measure, the personal consumption expenditures index, climbed to 1.5% in January from 1.3% in December, having previously hovered just above 1% for a few months. So policymakers are still well short of target, and even further from the overshoot implied in the new framework.

BETTER TOO HIGH THAN TOO LOW

Inflation expectations, for their part, have hit multi-year highs according to market-based measures derived from inflation-protected bonds. The rollout of vaccinations and stronger-than-expected fiscal support from Washington have combined to generate some investor concern that pent-up demand could lead to a burst of activity once the pandemic recedes.

This, though, may be a problem that Curdia would like to have.

"The difference between overshooting from above than from below is that we have the tools to fight inflation," he said. Meanwhile, he noted, "I haven't seen a significant and consistent increase in the different measures across the board."

Curdia's research points to the need for monetary policy to be more aggressive when disinflationary pressures such as those posed by the Covid shock coincide with a period of very low interest rates not just at home but in most developed economies. This perspective, echoed in statements by top policy makers, helps explain why the Fed is comfortable with its loose monetary policy even as the fiscal authorities loosen their purse strings.

"We have a lot more experience in fighting inflation from above than from below," Curdia said, noting that when inflation falls the Fed is restricted by the zero lower bound on interest rates.

FISCAL FACTORS

The Fed kept official rates at effectively zero for several years following the Great Recession of 2007-2009, then raised them gradually between 2015-2018. In March 2019, as the pandemic shock hit, the federal funds rate was brought quickly down to near zero again and the Fed has been buying USD120 billion in bonds per month.

"In the absence of those low interest rates inflation would have been a lot further below target. It is pushing inflation up compared to the alternative," Curdia said.

Market fears of an upward inflation swing have picked up since the election of President Joe Biden with a slim Democratic majority in Congress led to the prospect of much larger fiscal programs than had previously been in the cards.

Not only did Congress approve a USD900 billion stimulus in December, Biden also looks set to get much of his USD1.9 trillion proposal passed into law, with talk of additional infrastructure spending after that already emerging.

But Curdia said the Fed has shown a strong commitment to its price stability mandate in both directions, and would never let inflation expectations becoming unduly elevated without taking action to tamp them down.

"If there's one thing everyone knows is that you can't let inflation expectations get unanchored," he said.