MNI POLICY: SF Fed Paper: Inflation Not Driven by Slack

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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