Thursday, September 23, 2010

Inflation Below (Unofficial) Target

In its Tuesday statement, the Federal Open Market Committee said that inflation is too low for its taste:
Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.  
Of course, we're used to central banks worrying about inflation becoming too high, so this is an unusual thing to see.  As Gavyn Davies writes:
The Federal Reserve broke a taboo yesterday when it said quite baldly that inflation in the US is now below the level “consistent with its mandate”. In other words, it is too low. This is a very big statement for any central banker to make, since the greatest feather in their collective cap is that they successfully combated inflation after the 1970s debacle. Led by the Fed’s Paul Volcker, they re-asserted the importance of monetary policy, after two decades of failed wage and price controls. Since that period, most central bankers have been careful to avoid any language which even hints that a rise in inflation is acceptable to them. I can certainly find no previous record of the FOMC saying that inflation is too low, so it was a jolt to see this stated so starkly in the Fed statement yesterday.  
Those who are still worrying about inflation, in spite of the data, are fighting the last war.  Fortunately, the Fed isn't interpreting the "price stability" part of its mandate to mean "zero inflation." The projection of board members' for inflation in the "longer run" can be taken as its unofficial target; as of the last release in June, they were aiming for expecting 1.7%-2.0% (as measured by the deflator for personal consumption expenditures). 

Both the consumer price index (red line) and core PCE deflator are consistent with the notion that the Fed is missing its target.

Moreover, the markets are skeptical that the Fed will hit it in the future, according to the Cleveland Fed:
The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.54 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade.
Moreover, the Cleveland Fed's estimates are for CPI inflation, which is generally higher than PCE inflation.

The Fed didn't actually do anything about this, but the acknowledgment of the problem is a step in the right direction.

2 comments:

snoring solutions said...

It also raises the question the extent of preference for ideology over fact that biases the extreme from the center and demotes them from being scientists if not economists.

Bianca Vergara said...

I don't understand, how does inflation affect the American society besides the cost of living and government revenue?