Must-Read: Mark Thoma: U.S. Inflation Developments

Must-Read: The highly-estimable Mark Thoma turns Stan Fischer’s Jackson Hole Speech into a Q&A:

Mark Thoma: U.S. Inflation Developments: “A speech by Stanley Fischer at Jackson Hole turned into a pretend interview…

…Let me start be asking about your view of the economy. How close are we to a full recovery?

Although the economy has continued to recover and the labor market is approaching our maximum employment objective, inflation has been persistently below 2 percent. That has been especially true recently… the drop in oil prices… 12-month changes in the overall personal consumption expenditure (PCE) price index have recently been only a little above zero…. Measures of core inflation have been persistently below 2 percent throughout the economic recovery. That said, as with total inflation, core inflation can be somewhat variable….

Isn’t there reason to believe these numbers are true, i.e. doesn’t the slack in the labor market imply low inflation?

Of course, ongoing economic slack is one reason core inflation has been low…. We started seven years ago from an unemployment rate of 10 percent, which guaranteed a lengthy period of high unemployment. Even so… we might therefore have expected both headline and core inflation to be moving up more noticeably toward our 2 percent objective. Yet, we have seen no clear evidence of core inflation moving higher over the past few years…. [The] role for slack in helping to explain movements in inflation… is… modest… and can easily be masked….

If that’s true, if the decline in the slack in the labor market does not translate into a notable change in inflation, why is the Fed so anxious to raise rates based upon the notion that the labor market has almost normalized? Is there more to it than just the labor market?…

A larger effect comes from changes in the exchange value of the dollar…. A higher value of the dollar passes through to lower import prices… restrains the growth of aggregate demand and overall economic activity….

That argues against a rate increase, not for it….

Commodity prices other than oil are also of relevance for inflation….

So you must believe that all of these forces holding down inflation (many of which are stripped out by core inflation measures, which are also low) that these factors are easing, and hence a spike in inflation is ahead?

The dynamics with which all these factors affect inflation depend crucially on the behavior of inflation expectations…. Longer-term inflation expectations in the United States appear to have remained generally stable since the late 1990s… [and so] movements in inflation have tended to be transitory.

Let’s see, lots of factors holding down inflation, longer-term inflation expectations have been stable throughout the recession and recovery, remarkably so, yet the Fed still thinks a rate raise ought to come fairly soon?

We should however be cautious in our assessment that inflation expectations are remaining stable…. Measures of inflation compensation in the market for Treasury securities have moved down somewhat…. But these movements can be hard to interpret….

I have to be honest. That sounds like the Fed is really reaching to find a reason to justify worries about inflation and a rate increase. Let me ask this a different way. In the Press Release for the July meeting of the FOMC, the committee said it can be “reasonably confident that inflation will move back to its 2 percent objective over the medium term.” Can you explain this please? Why are you “reasonably confident” in light of recent history?

Can the Committee be “reasonably confident that inflation will move back to its 2 percent objective over the medium term”?… There is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further…. Slack in the labor market has continued to diminish, so the downward pressure on inflation from that channel should be diminishing as well…. The Committee has indicated in its post-meeting statements that it expects inflation to return to 2 percent. With regard to our degree of confidence in this expectation, we will need to consider all the available information and assess its implications for the economic outlook before coming to a judgment….

I just hope that information includes… the Fed’s own eagerness to see “green shoots” again and again, far before it was time for such declarations. What might deter the Fed from its intention to raise rates sooner rather than later?…

We are interested also in aspects of the labor market beyond the simple U-3 measure of unemployment, including for example the rates of unemployment of older workers and of those working part-time for economic reasons; we are interested also in the participation rate. And in the case of the inflation rate we look beyond the rate of increase of PCE prices and define the concept of the core rate of inflation.

I find these kinds of statement difficult to square with the statement that labor markets are almost back to normal…. When rates do go up, how fast will they rise?

With inflation low, we can probably remove accommodation at a gradual pace. Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening. Should we judge at some point in time that the economy is threatening to overheat, we will have to move appropriately rapidly….

The Fed has said again and again that it’s 2 percent inflation target is symmetric with respect to errors, i.e. it will get no more worried or upset about, say, a .5 percent overshoot of the target than it will an undershoot of the same magnitude (2.5 percent versus 1.5 percent). However, many of us suspect that the 2 percent target is actually a ceiling… and statements such as this do nothing to change that view…. I wish we had time to hear your response…

August 30, 2015

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