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By Jean Yung
     WASHINGTON (MNI) - Inflation has been driven primarily by price
expectations rather than by economic slack in recent years, according to a paper
published Monday from the Federal Reserve Bank of San Francisco. 
     Historically low unemployment and higher economic growth indicate there is
limited economic slack, but core inflation rested at the Fed's 2% target in the
third quarter of 2018, according to the paper. Wage pressures appear also to be
well contained, suggesting the Phillips Curve relationship between slack and
inflation has "weakened substantially."   
     "Our estimates show that, in the years since the Great Recession, inflation
has been driven primarily by public expectations of future inflation rather than
by economic slack," economists Oscar Jorda, Chitra Marti, Fernanda Nechio and
Eric Tallman wrote in an Economic Letter. 
     They found that changes in economic slack have had next to no effect on
inflation before and after the Great Recession. However, "inflation persistence"
has declined considerably. An unanticipated percentage point increase in
inflation will raise inflation in the next quarter by about 0.45 percentage
point, whereas prior to 2007, the effect on inflation would be about 0.71
percentage point.
     On the other hand, the contribution of future inflation expectations has
almost doubled since the Great Recession. 
     This increased importance of inflation expectations suggests that
conducting policy consistently to keep expectations well-anchored to the target
is key to avoiding large swings in inflation, according to the research. 
     "When policy is set consistently, the public discounts deviations of the
unemployment rate from its natural rate and of inflation from its target as
transitory," the paper said. 
     The paper is online at:
https://www.frbsf.org/economic-research/publications/economic-letter/2019/februa
ry/inflation-stress-testing-phillips-curve/
--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com
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