On Wednesday the five year old break-even inflation rate fell to 2.48 percent. If that doesn’t mean anything to you – which is totally forgivable if you’re not a professional economics viewer – try this: wholesale price of gasoline has fallen 80 cents a gallon since the peak a month ago. Only a little bit of this dive has been passed on to consumers so far, but in the next few weeks we will be plausible to see a wide fall in prices at the pump.
Besides, what are the chances that falling gas prices will get even a small fraction of the media attention devoted to rising prices?
Where do these numbers and a growing accumulation of other data come from? rents until postage costs, suggest is that the risk of stagflation is decreasing. That is good news. But I fear that policymakers, especially at the Federal Reserve, are slowly adjusting to the new information. They were clearly too complacent about rising inflation (like me!); but now they may be holding on to a hard money stance for too long and creating a gratuitous recession.
Let’s talk about what the Fed is afraid of.
It is clear that we have had serious inflation problems over the past year and a half. Much, probably most of this inflation probably reflected temporary delivery interruptions ranging from supply chain problems to the Russian invasion of Ukraine. But part of the increase in inflation was certainly also the result of an overheated domestic economy. Even those of us who are mostly monetary pigeons agreed that the Fed needed to raise interest rates to cool the economy — and it did. The Fed’s rate hikes, plus the anticipation of further hikes, have caused interest rates that matter to the real economy, especially mortgage rates — increase, which will reduce overall expenditure.
Indeed, there is early evidence of a significant economic slowdown†
But the just released minutes From last month’s meeting of the Fed’s Open Market Committee, which sets interest rates, significant fears that just cooling the economy won’t be enough, that expectations of future inflation will be lowered.”not anchored‘ and that inflation ‘could anchor’.
In principle, this is not a foolish concern. In the 1970s, just about everyone started to expect continued high inflation, and this expectation was built into pay and pricing — for example, employers were willing to lock in pay increases of 10 percent per year because they expected all their competitors to do the same. To purge the economy of those entrenched expectations, it took a long period of very high unemployment – stagflation.
But why did the Fed believe such a thing could happen now? Both the minutes and comments from Chairman Jerome Powell suggest that an important factor was a preliminary publication of research results from the University of Michigan, which to jump in long-term inflation expectations.
Even at that time, some of us warned against too much weight on one number, especially considering that other numbers didn’t tell the same story. Sure enough, the Michigan song was a blip: most of that jump in inflation expectations went away when revised data was released a week later.
And for what it’s worth, the financial markets are now sounding more or less perfectly clear about continued inflation. That five-year break-even is the spread between ordinary interest rates and the interest rates on bonds that are protected against rising prices; it is thus an implicit prediction of future inflation. And a better look at the markets shows not only that they expect relatively low inflation over the medium term, but also that they expect it to decline after about a year and then return to levels consistent with the Fed’s long-term target.
To be fair, bond traders don’t set wages and prices, and it is in principle possible for inflation to become entrenched in the minds of workers and companies even if investors decide it is under control. But it’s not likely.
There may also be an element of self-denying forecasting here, with investors softening their expectations of future inflation precisely because they expect the Fed to hit the brakes too hard.
Still, it’s troubling to read reports suggesting the Fed is a more hawkish even as the economy is weakening and the prospects for sustained inflation are declining.
I’m not exactly sure what’s going on here. Part of that may be policymakers’ all-too-common tendency to double down on a price even when the facts no longer support it. Part of it may be that after they get through inflation incorrectly, Fed officials, perhaps unknowingly, are prone to harassment from determined Wall Street types. hysterical about future inflation† And in part, they may simply be compensating for their previous underestimation of inflation risks.
Anyway, there’s an old joke about the motorist hitting a pedestrian and then trying to correct the mistake by backing up – running over the pedestrian a second time. I fear something like this is about to happen in economic policy.