Behind the Fed’s confidence in inflation, some anxiety is setting in

The Federal Reserve sticks to its story. The factors that pushed annual core inflation to an almost 30-year high of 3.8% in May are largely “transient,” he said Wednesday.

President Jerome Powell reiterated this point several times during his press conference: “We expect these high inflation numbers… will start to decline. The surge in used car prices will reverse like that of lumber has already done, he said. Fed officials expect inflation to slow from 3.4% at the end of this year to 2.1% by the end of next year and to 2.2% by the end of next year the end of 2023. The last two digits are each up one tenth of a percentage point from March. provide.

But beneath the surface, a certain anxiety sets in. In March, only five of 18 Federal Open Market Committee participants believed inflation risks were weighted up. By June, that number had risen to 13. In other words, a solid majority of Fed officials believe inflation is more likely to be higher than lower than expected.

The Federal Reserve expects the surge in used car prices to reverse.


Jim Watson / Agence France-Presse / Getty Images

These shifting risks have made their way into the opinions of officials on rates. The median projection is now for a rate hike of half a percentage point by the end of 2023, compared to the March expectation with no change. Why are officials in a more rush to hike rates now than in March, given little change in their outlook? Mr. Powell said it was a matter of trust. The Fed had set two conditions to finally raise interest rates: inflation lasting 2% and expected slightly above it, and full employment. Many officials “are more comfortable with the economic conditions in [their] the forecasts will be met sooner than expected, ”he said. “And that would be a welcome development.”

That said, it appears that their confidence in reaching the inflation target increased more than their confidence in reaching the full employment target. In fact, taken literally, the inflation target may already have been met. Inflation is now above 2% and is expected to be slightly above over the next few years.

Federal Reserve Chairman Jerome Powell described the outlook for inflation in the US economy and said there were signs that rapidly rising prices should stop rising and fall. Credit: Al Drago / Associated press

The problem is that this did not happen as planned in the new strategic framework unveiled last year. Since inflation was below its 2% target, the Fed wanted inflation to just go over 2% to average 2% over time. To achieve this, it would leave the economy to overheat, reducing unemployment to pre-pandemic levels below 4%. That would push inflation just above 2% for a while, a process he said would take several years.

Instead, inflation skyrocketed due to the collision of high demand and tight supply, which held back job growth. This kind of inflation is an idiosyncratic supply shock of the kind that central banks have long struggled with, Mr Powell said.

As long as this increase is truly transient, the Fed should be fine. And on this, the Fed has an important ally: the bond market, which believes that inflation will fall again. But if these supply shocks raise public inflation expectations, which tend to be self-fulfilling, the Fed has a problem. She could no longer stick to her plan to wait for the return to full employment before tightening monetary policy. While Mr Powell said the rise in expectations has yet to reach worrying levels, “We are by no means dismissing the opportunity.” And in that case, he said, “We wouldn’t hesitate to use our tools to solve this problem. Price stability is half of our mandate.

Write to Greg Ip at [email protected]

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Appeared in the print edition of June 17, 2021 under the title “Beneath Confidence, Also Some Anxiety”.

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