Tag: Inflation Expectations

Must-Read: Ben Eisen: Newest Inflation Expectations Likely to Trouble the Fed

Posted on by Brad DeLong
Www sca isr umich edu files tbcpx1px5 pdf

Must-Read: Ben Eisen: Newest Inflation Expectations Likely to Trouble the Fed: “The Federal Reserve probably won’t like the latest data out of the University of Michigan on Friday…

…inflation expectations over the next five to ten years dropping to 2.3% in June, a record low…. That’s on top of market-based inflation expectations that have also fallen over the past month…. When Federal Reserve Chairwoman Janet Yellen spoke on Monday, she drew attention to inflation expectations as a key input in actual inflation. She said:

It is unclear whether these indicators point to a true decline in those inflation expectations that are relevant for price setting; for example, the financial market measures may reflect changing attitudes toward inflation risk more than actual inflation expectations. But the indicators have moved enough to get my close attention. If inflation expectations really are moving lower, that could call into question whether inflation will move back to 2 percent as quickly as I expect….

The market is taking note as well. Benchmark 10-year Treasury note yields dropped to their lowest of the day after the data and recently traded at 1.63%, a new low for the year on a closing basis…

Inflation Becomes Key as Investors See Economic Weakness MoneyBeat WSJ

Must-read: Olivier Blanchard et al.: “Inflation and Activity–Two Explorations and their Monetary Policy Implications”

Posted on by Brad DeLong

Must-Read: Olivier Blanchard, Eugenio Cerutti, and Lawrence Summers: Inflation and Activity–Two Explorations and their Monetary Policy Implications: “Since the mid-1970s, short-run inflation expectations have become more stable…

…(λ has increased), and… the slope of the Phillips curve (θ) has flattened over time, with nearly all of the decline taking place from the mid-1970s to the early 1990s…. For most countries, the coefficient θ today is not only small, but also statistically insignificant…

Https www imf org external pubs ft wp 2015 wp15230 pdf

Must-read: Narayana Kocherlakota: “Information in Inflation Breakevens about Fed Credibility”

Posted on by Brad DeLong
Graph 5 Year 5 Year Forward Inflation Expectation Rate FRED St Louis Fed

Must-Read: Narayana Kocherlakota: Information in Inflation Breakevens about Fed Credibility: “The ten-year breakeven refers to the difference in yields between a standard (nominal) 10-year Treasury and an inflation-protected 10-year Treasury (called TIPS)…

…The five-year breakeven is the same thing, except that it’s over five years…. The five-year five-year forward breakeven is defined to be the difference between the 10-year breakeven and the five-year breakeven… shaped by beliefs about inflation over a five year horizon that starts five years from now… conceptually… the sum of… 1. investors’ best forecast about what inflation will average 5 to 10 years from now, [and] 2. the inflation risk premium over a horizon five to ten years from now…. My own assessment is that both components have declined. But my main point will be a decline in either component is a troubling signal about FOMC credibility.  

It is well-understood why a decline in the first component should be seen as problematic for FOMC credibility. The FOMC has pledged to deliver 2% inflation over the long run…. A decline in the first component of breakevens signals a decline in this form of credibility…. A decline in the inflation risk premium means that investors… increasingly see standard Treasuries as being a better hedge…. But Treasuries are only a better hedge than TIPs against macroeconomic risk if inflation turns out to be low when economic activity turns out to be low…. [Thus] a decline in the inflation risk premium… reflects investors’ assigning increasing probability to a scenario in which inflation is low over an extended period at the same time that employment is low….

In the world of policymaking, no signal comes without noise.  But the risks for monetary policymakers associated with a slippage in the inflation anchor are considerable.   Given these risks, I do believe that it would be wise for the Committee to be responsive to the ongoing decline in inflation breakevens by reversing course on its current tightening path.

Must-Read: Paul Krugman: Anchors Aweigh

Posted on by Brad DeLong

Must-Read: The answer, presumably, is the same as it was in the 1960s and 1970s: that “too big” a deviation from the anchored level of inflation for “too long” will de-anchor inflation, for weasel parameters “too big” and “too long”.

It has always seemed to me that if inflation expectations are “well anchored”, then monetary policy is obviously too tight. There are very powerful upsides from a higher-pressure economy. There are no downsides unless inflation expectations are barely-anchored–in which case a higher-pressure economy runs the risk of de-anchoring them, with associated costs. But with well-anchored inflation expectations there is a substantial amount of slack somewhere in the policy-optimization problem. And no professional economist should be happy or comfortable with such an outcome.

Paul Krugman: Anchors Away: “Since 2008… demand-side events have been very much what people using IS-LM would have predicted (and did)…

…But on the supply side, not so much…. Model-oriented public officials and research staff at policy institutions… [now] say… they work with… ‘anchored’ expectations… [which] don’t change their expectations in the face of recent experience… like the old, pre-NAIRU Phillips curves people estimated in the 1960s. And… such curves fit pretty well on data since 1990….

Where does anchoring come from and how far can it be trusted? Is it the consequence of central bank credibility, or is it just the consequence of low inflation?… Second… the anchored-expectations hypothesis tells a very different story about capacity and policy…. Let me illustrate this point with the case of the euro area…. Euro core inflation is currently about 1 percent; the slope of the Phillips relationship is around 0.25; so getting back to 2 should require a 4 percentage point fall in unemployment. That’s a lot! How much output growth would this involve?… This naive calculation puts the euro area output gap at 8 percent, which is huge. Should we take this seriously? If not, why not?

Anchors Away Slightly Wonkish The New York Times

http://krugman.blogs.nytimes.com/2015/12/04/anchors-away-slightly-wonkish/

Must-Read: Menzie Chinn: “Inflation Expectations Can Change Quickly…”

Posted on by Brad DeLong

Must-Read: It is not clear to me that inflation expectations would undergo a “rapid and dramatic shift” even if we had a “drastic regime change”. Or rather, as Stan Fischer told me when we were discussing Tom Sargent’s “Stopping Moderate Inflation” and “End of Four Big Inflations” papers, we say after the fact that we had a drastic regime change if and only if inflation expectations underwent a rapid and dramatic shift. It’s not something that one can do–especially living, as we do, not in Plato’s Republic but in Romulus’s Sewer…

Menzie Chinn: “Inflation Expectations Can Change Quickly…”: “One of the arguments for acting sooner rather than later on monetary policy…

…is that if the slack disappears, inflationary expectations will surge… [aA] in this quote from reader Peak Trader’s comment…. I am sure if there is a drastic regime change, one could see a rapid and dramatic shift in measured expectations; the question is whether that scenario is relevant and/or plausible…. I will let readers decide whether expectations turned on a dime. They seem pretty adaptive to me.

Inflation expectations can change quickly Econbrowser