Fed lost some cred­i­bil­ity on in­fla­tion, ad­mit of­fi­cials

Financial Chronicle - - PLAN, POLICY - RICH MILLER

AN­CHORS aweigh? Af­ter years of main­tain­ing that in­fla­tion ex­pec­ta­tions were sta­ble and solidly grounded, Fed pol­i­cy­mak­ers are start­ing to recog­nise a small but wor­ry­ing soft­en­ing in the out­look that con­sumers, busi­nesses and in­vestors have for prices. “They’re ac­knowl­edg­ing that the in­fla­tion­ary an­chor has slipped a bit,” said Ethan Har­ris, head of global eco­nomics re­search at Bank of Amer­ica Mer­rill Lynch in New York.

That’s a con­cern be­cause ex­pec­ta­tions shape how house­holds and firms act and thus help de­ter­mine where in­fla­tion ac­tu­ally ends up. Con­sumers ac­cus­tomed to mea­ger in­fla­tion will re­sist pay­ing up for goods and ser­vices. Com­pa­nies, in turn, will avoid hand­ing out wage in­creases be­cause they fear they won’t be able to raise prices to cover the added la­bor costs. It’s a vi­cious cir­cle that can con­strain the Fed from achiev­ing its 2 per cent in­fla­tion tar­get.

“There is no sin­gle highly re­li­able mea­sure” of longer run in­fla­tion ex­pec­ta­tions, Fed gover­nor Lael Brainard told The Eco­nomic Club of New York on Septem­ber 5. “None­the­less, a va­ri­ety of mea­sures sug­gest un­der­ly­ing trend in­fla­tion may cur­rently be lower than it was be­fore the cri­sis” of 20082009, Brainard said.

The fu­ture course of prices is likely to fea­ture promi­nently when Fed chair­per­son Janet Yellen and her col­leagues meet to dis­cuss mon­e­tary pol­icy on Septem­ber 19-20. They’re widely ex­pected to de­cide to keep in­ter­est rates un­changed while an­nounc­ing the start of a slow-mo­tion plan to pare back the cen­tral bank’s $4.5 tril­lion bal­ance sheet.

Cen­tral bank of­fi­cials prepar­ing for the meet­ing will get an up­date of the in­fla­tion pic­ture on Thurs­day with the re­lease of the con­sumer price index for Au­gust. It’s ex­pected to show that prices rose 1.8 per cent from a year ear­lier, up from July’s 1.7 per cent an­nual in­crease, ac­cord­ing to the me­dian pro­jec­tion of econ­o­mists sur­veyed by Bloomberg.

Brainard sug­gested in New York that the slip­page in the out­look for prices might be one rea­son for the cen­tral bank to hold off from rais­ing in­ter­est rates for a third time this year.

Fed­eral Re­serve Bank of Chicago pres­i­dent Charles Evans has made a sim­i­lar case in ar­gu­ing for a more cau­tious ap­proach to in­creas­ing rates.

It’s not only the more dovish mem­bers of the pol­icy-set­ting Fed­eral open mar­ket com­mit­tee (FOMC) that have taken note. New York Fed pres­i­dent Wil­liam Dud­ley has left open the pos­si­bil­ity that ex­pec­ta­tions have eased, say­ing on Septem­ber 7 that they “were well an­chored at or slightly be­low our 2 per cent ob­jec­tive.”

Cleve­land Fed pres­i­dent Loretta Mester, one of the more hawk­ish mem­bers of FOMC, agreed that an un­moor­ing of ex­pec­ta­tions would be a big prob­lem for Fed, though she ar­gued in a speech last week that she didn’t think that would hap­pen. She de­scribed them as “rea­son­ably sta­ble.”

Brainard said Fed’s fail­ure to lift in­fla­tion to its tar­get since the goal was in­tro­duced in Jan­uary 2012 may have in­flu­enced how com­pa­nies and con­sumers view the out­look. “House­holds and firms have ex­pe­ri­enced a pro­longed pe­riod of in­fla­tion be­low our ob­jec­tive, and that may be af­fect­ing their per­cep­tion of un­der­ly­ing in­fla­tion,” she said.

Evans, for his part, blamed “con­ser­va­tive” cen­tral bankers for the short­fall in a May 25 speech in Tokyo, with­out sin­gling out any­one in par­tic­u­lar for crit­i­cism. “In­fla­tion ex­pec­ta­tions have drifted down since 2014 and are a big ex­pla­na­tion for why in­fla­tion has fallen re­cently” even as the labour mar­ket has tight­ened, said Jean Boivin, head of eco­nomic re­search at Black Rock Inc’s In­vest­ment In­sti­tute.

The per­sonal con­sump­tion ex­pen­di­tures price index, the Fed’s pre­ferred mea­sure of in­fla­tion, rose 1.4 per cent in the 12 months through July. That’s down from 2.2 per cent in Fe­bru­ary. The index has fallen short of 2 per cent more than 90 per cent of the time since the cen­tral bank adopted that level as its goal.

Yellen told law­mak­ers in July that tran­si­tory fac­tors such as a steep de­cline in cell phone ser­vice prices may be partly re­spon­si­ble for the re­cent soft­ness in the price gauge.

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