MNI INTERVIEW: Inflation Understated On Seasonals- Ex Fed Aide

U.S. inflation may be higher than government statistics have shown because of big seasonal adjustments earlier in the year and because those filters haven't properly accounted for the Ukraine war, former Fed staffer and expert on seasonal adjustments Jonathan Wright told MNI.

"I suspect that that update of the seasonal factors was actually incorrect or at least was due to the special things that happened in early 2022" including Russia's invasion of Ukraine, said Wright, whose past work on seasonal adjustments has been published by the Fed system. "If that's right, if the seasonal factor has been incorrectly bumped up in the first half of the year, that means that we're understating inflation today and we will be overstating it later in the year."

Wright encouraged Fed policymakers look at the 12-month change rather than month-on-month changes. "I would suggest that what they do is think hard about how unusual factors in 2022 might have distorted seasonals and think about whether there's possibly some distortion that they want to look through."

Inflation this year won't moderate as far as the median Fed official expects according to Wright, a former deputy associate director at the Board's division of monetary affairs.

"Inflation is coming down through a combination of special factors waning through the effects of tighter monetary policy, through the fact that fiscal policy has gone from stimulative to actually slowing," he said. Still, the March SEP showing PCE inflation coming down to 3.3% and core to 3.6% looks optimistic, he added.

NO RATE-CUT CLIFF

Shaving off the last percentage point of inflation could entail more pain than the central bank is willing to countenance, he said. "To get it all the way down to 2% you're going to have to really weaken the labor market. You're going to have to get the unemployment rate up to and above the natural rate and I don't think that the Fed actually has the stomach to do that, at least not for the purpose of getting inflation from 3 to 2%." he said. "They'll let that be opportunistic."

Fed officials in their dot plot forecasts have already implied there could be a mild recession this year, Wright said, an outlook he agrees with.

"The SEP has unemployment rising over a percentage point this year and that is very close to saying that the policymakers expect a recession," he said. Wright pointed to work by Claudia Sahm that a recession starts when the three-month moving average of the unemployment rate rises half a percentage point or more relative to its low during the previous 12 months.

Given the downside risk of recession and the inflation pressures the Fed will likely hike one more time and pause, Wright said, rejecting signals in financial markets of multiple rate cuts later this year. (See: MNI INTERVIEW: Fed Close To Done As Credit Tightens–Kroszner)

"The labor market would have to really fall off a cliff or there would have to be a full blown financial crisis for the Fed to start easing with inflation anything like where it is," said Wright, who recently published a paper with co-writers at the Fed Board. "Of course that makes the Fed's life harder because financial conditions are easier than the Fed would like them to be."