[Following Russias invasion of Ukraine, the bond markets 5-10 year
projection of annual chain-weighted personal-consumption-expenditures
inflation reached 2.27%, raising concerns that another big shock could
de-anchor inflation expectations. But since that didnt happen, the
Federal Reserve now should reconsider its position. ]
[[link removed]]

THE NEW INFLATION PICTURE  
[[link removed]]


 

J. Bradford Delong
December 28, 2022
Project Syndicate
[[link removed]]


*
[[link removed]]
*
[[link removed]]
*
*
[[link removed]]

_ Following Russia's invasion of Ukraine, the bond market's 5-10 year
projection of annual chain-weighted personal-consumption-expenditures
inflation reached 2.27%, raising concerns that another big shock could
de-anchor inflation expectations. But since that didn't happen, the
Federal Reserve now should reconsider its position. _

, Clip Somodevilla/Getty Images

 

Following Russia's invasion of Ukraine, the bond market's 5-10 year
projection of annual chain-weighted personal-consumption-expenditures
inflation reached 2.27%, raising concerns that another big shock could
de-anchor inflation expectations. But since that didn't happen, the
Federal Reserve now should reconsider its position.

BERKELEY – At the start of February 2022, the five-year,
five-year-forward consumer-price-index (CPI) inflation break-even rate
in the US bond market was hovering at around 2%
[[link removed]] per year – a figure
that corresponds to a chain-weighted personal-consumption-expenditures
(PCE) inflation forecast of 1.6% per year 5-10 years from now. Since
1.6% inflation is materially below the US Federal Reserve’s 2%
target, I entered that month feeling quite good about being on “Team
Transitory” – or at least on “Team The Fed Has Got This” or
“Team Inflation Expectations Remain Solidly Anchored.”

But then, at the end of that month, Russian President Vladimir Putin
– the wannabe Grand Prince of Muscovy – ordered a blitzkrieg
invasion of Ukraine. Things did not go as he had planned. The
Ukrainians fended off the initial onslaught, and both sides settled in
for a longer war of attrition. Energy, grain, and fertilizer prices
skyrocketed. The world began to worry that, come winter, Europe would
freeze and many other countries – from Egypt to Nigeria – would
starve.

Owing to these fears, the five-year, five-year-forward CPI inflation
rate shot up from 2% per year to its peak of 2.67%
[[link removed]] on April 21, 2022, while
expectations of annual PCE inflation 5-10 years hence reached 2.27%.
That PCE projection suggested that bond traders had not lost
confidence in the Fed’s commitment to its inflation target.

But if one supposes that the width of the Fed’s target zone is 0.6
percentage points – meaning the bond market expects the central bank
to remain on target if five-year, five-year-forward CPI inflation
remains between 2% and 2.6% – that April 2022 peak raised concerns.
For those whose hair was already on fire, there was every reason to
fear that we were just one more big supply shock away from losing the
inflation-expectations anchor that has kept prices relatively stable
for decades.

Perhaps we were. But since we did not get that additional large
adverse supply shock, it hardly matters now. The PCE-chain inflation
rate for November was just 0.16%, which is less than 2% per year when
multiplied by 12. To be sure, one swallow does not make a summer, and
one data point does not make a trend. Even the decline from 0.62% in
June (7% per year
[[link removed]]) is not
necessarily bankable. After all, we also saw some declines between
December 2021 and April 2022, and between August 2021 and December
2021.

As I have said before, this pandemic business cycle has been one of
those rare periods when I have not envied the members of the Federal
Open Market Committee (FOMC). What they do over the next six months
will not really affect the real economy of demand, employment, and
production until one year from now, and it will not meaningfully
affect the inflation news until a year and a half from now. There will
be many new developments over the next 18 months – some of them
good, and some of them bad.

Regardless of what the Fed decides to do, it is almost certain to have
some regrets afterwards. Will it continue to overdo interest-rate
hikes? If so, the economy, two years from now, will be mired once
again in secular stagnation – with interest rates at their zero
lower bound, and no visible path for a rapid return to full
employment. Will the economy achieve a “soft landing” through
immaculate disinflation, or will additional supply shocks and
political pressures throw us into stagflation and a painful and
prolonged recession?

Nobody knows. But if I was on the FOMC right now, I would keep two
considerations in mind. First, the Fed does not have to move slowly.
The past six months have shown that there are very few downsides to
rapid monetary-policy changes. Until this month, the Fed was raising
interest rates by a massive 75 basis points at a time, and even that
rate is not a speed limit. The FOMC should take advantage of this
apparent optionality. When the situation is unclear, it can pause,
confident in the knowledge that it can then move very fast when the
situation becomes clear.

Second, in retrospect, former Fed Chair Alan Greenspan’s 1996
decision to set the inflation target at 2% per year was very ill
advised. Yes, there may be substantial benefits from maintaining and
strengthening the Fed’s credibility by getting the economy back to
the 2% annual target, even if that target will be raised in the medium
term. But is that really the kind of credibility the Fed wants to
have? Is it good for markets to think that you will persist with
policies that no longer fit new circumstances, just because you said
you would? Once again, I do not envy the members of the FOMC this
winter.

_J. BRADFORD DELONG, Professor of Economics at the University of
California, Berkeley, is a research associate at the National Bureau
of Economic Research and the author of Slouching Towards Utopia: An
Economic History of the Twentieth Century
[[link removed]] (Basic
Books, 2022)._

_PROJECT SYNDICATE produces and delivers original, high-quality
commentaries to a global audience. Featuring exclusive contributions
by prominent political leaders, policymakers, scholars, business
leaders, and civic activists from around the world, we provide news
media and their readers with cutting-edge analysis and
insight, regardless of ability to pay. Our membership includes over
500 media outlets – more than half of which receive our commentaries
for free or at subsidized rates – in 158 countries._

* inflation
[[link removed]]
* Russia
[[link removed]]
* Ukraine
[[link removed]]
* war
[[link removed]]
* Federal Reserve Bank
[[link removed]]

*
[[link removed]]
*
[[link removed]]
*
*
[[link removed]]

 

 

 

INTERPRET THE WORLD AND CHANGE IT

 

 

Submit via web
[[link removed]]

Submit via email
Frequently asked questions
[[link removed]]

Manage subscription
[[link removed]]

Visit xxxxxx.org
[[link removed]]

Twitter [[link removed]]

Facebook [[link removed]]

 




[link removed]

To unsubscribe, click the following link:
[link removed]