Fed’s Fischer: ‘Good Reason’ to Think US Inflation Will Move Higher

30 Aug 2015 | Author: | No comments yet »

Fed, ECB and BOE Policy Makers All Say They See Inflation Rising.

JACKSON HOLE (Wyoming) • The US Federal Reserve will give serious consideration to raising its benchmark interest rate in the middle of next month, particularly if volatility subsides in financial markets, according to a number of Fed officials last Friday. JACKSON HOLE, Wyo. (Reuters) – U.S. inflation will likely rebound as pressure from the dollar fades, allowing the Federal Reserve to raise interest rates gradually, Fed Vice Chairman Stanley Fischer said on Saturday in a speech careful not to overreact to a possible Chinese slowdown.Stronger growth will pull inflation higher in the U.S. and Europe, according to three top central bankers who voiced confidence that their regions will escape from headwinds that are keeping inflation too low. The influential U.S. central banker was circumspect whether he would prefer to raise rates from near zero at a much-anticipated policy meeting on Sept. 16-17.

I will focus my remarks today on forces–domestic and international–that have been holding down inflation in the United States,1 and some of the consequences of recent– primarily international–developments. Although the economy has continued to recover and the labor market is approaching our maximum employment objective, inflation has been persistently below 2 percent. Fischer briefly referenced concerns about China’s slowdown, saying the Fed is “following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual.” Fischer said oil’s plunge not only affects total inflation but can drag down core inflation.

Speaking at an annual symposium sponsored by the Kansas City Fed in the foothills of the Grand Tetons, Fischer expressed faith in the central bank’s ability to return inflation to its goal of 2 percent, which is generally associated with a healthy economy. That has been especially true recently, as the drop in oil prices over the past year, on the order of about 60 percent, has led directly to lower inflation as it feeds through to lower prices of gasoline and other energy items. While U.S. officials are weighing the timing of their first interest-rate increase since 2006, and the Bank of England may tighten in early 2016, the ECB has heard calls to extend its quantitative easing program to provide more protection against potential deflation. “The link between inflation and real activity appears to have strengthened in the euro area recently,” the ECB’s Constancio said in a paper delivered at Jackson Hole. “Provided our policies are able to significantly reduce the output gap, we can rely on a material effect to help bring the inflation rate closer to target.” Fed Chair Janet Yellen and ECB President Mario Draghi both skipped the Jackson Hole event this year. At the same time, Fischer, Carney and other policymakers are wrestling with the world’s stubbornly low levels of inflation, and recognising that the rapid pace of globalisation over the last quarter century may have made it harder for any individual country to move inflation higher. “There are profound secular and cyclical disinflationary forces at work in the global economy,” Carney said, making it harder for central banks in London, Washington and elsewhere to reach the inflation targets they have set as a core policy goal.

As a result, 12-month changes in the overall personal consumption expenditure (PCE) price index have recently been only a little above zero (chart 1). The central bank slashed its target interest rate to zero during the depths of the financial crisis in 2008 and has left it there ever since in hopes of fostering a stronger recovery. The Fed has said it wants to be reasonably confident that inflation, which has been stuck below its 2-percent target for a few years, will rebound in the medium term. Probabilities of a rate move at next month’s FOMC meeting were 38 percent at New York’s close on Friday, down from 48 percent on Aug. 14, according to trading in federal funds futures. Fischer said the dollar’s year-long rise played a big role in that weakness, and it could restrain U.S. gross domestic product growth through 2016 and even into 2017 – all the more reason to “proceed cautiously” in raising rates, he said.

But measures of core inflation, which are intended to help us look through such transitory price movements, have also been relatively low (return to chart 1). Government data released Friday showed prices, excluding food and energy, rose just 1.2 percent compared to a year ago — well below the Fed’s goal.

Outside the conference on Friday, Fischer made an impromptu television appearance to say it was too early to say whether the Fed should in September hike rates for the first time in nearly a decade. Markets, on alert for any sign policymakers were ruling out a September liftoff, read Fischer’s remarks as suggesting a tightening would at least come this year. While the world’s major central banks are focused on bringing inflation up, the lack of price pressure isn’t a universal problem, said Raghuram Rajan, governor of the Reserve Bank of India. “Unlike our other panelists, I have the problem of dealing with the traditional central banker problem of high inflation and the task of bringing it down,” he said. “We’re disinflating in a world of very low global inflation and that has problems.” The next week, the Labor Department announced that the economy had added an estimated 215,000 jobs in July. “We now await the results of the August employment survey,” Mr. Carney said a slowdown in China could depress UK inflation further but it did not, for now, change his central bank’s position on when and how it might raise rates.

The developments “are unlikely to change the process of rate increases from limited and gradual to infinitesimal and inert,” Carney told the conference, reiterating that the BoE’s policy decision would become clearer “around the turn of the year.” On average, CPI inflation tends to run a few tenths higher than PCE inflation, and, because the CPI has a modestly larger weight on energy prices, fluctuations in the CPI measure tend to be a bit larger.

Even so, with inflation expectations apparently stable, we would have expected the gradual reduction of slack to be associated with less downward price pressure. Fed models show a 10 percent spike in the greenback pushes down inflation over the same year as the rise but reduces economic growth in the following year. This fact helps drive home an important point: While much evidence points to at least some ongoing role for slack in helping to explain movements in inflation, this influence is typically estimated to be modest in magnitude, and can easily be masked by other factors.2 In the first instance, as already noted, core inflation can to some extent be influenced by oil prices. Minneapolis Fed President Narayana Kocherlakota has argued against a rate hike this year and for even an even looser stance of Fed policy. “Add up all the shortfalls of inflation,” Kocherlakota said in an interview here. “That can’t be viewed as having been a success on the monetary policy front.” Hedge fund investor Ray Dalio predicted this week that the Fed will unleash major stimulus before it tightens policy significantly. Officials say they are not inclined to act in the face of volatility, in part because they see little practical difference between moving in September and waiting a little longer.

Prices of metals and other industrial commodities, and agricultural products, are affected to a considerable extent by developments outside the United States, and the softness we’ve seen in these commodity prices, has in part reflected a slowing of demand from China and elsewhere. Thus, the stability of inflation expectations has prevented inflation from falling further below our objective than occurred, and it has enabled the Federal Open Market Committee to look through some upward inflation shocks without compromising price stability.5 We should however be cautious in our assessment that inflation expectations are remaining stable. But these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations, such as changes in demand for the unparalleled liquidity of nominal Treasury securities.

In determining how long to maintain this target range, the Committee will assess progress–both realized and expected– toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In the June SEP, the central tendency of FOMC participants’ projections for core PCE inflation was 1.3 percent to 1.4 percent this year, 1.6 percent to 1.9 percent next year, and 1.9 percent to 2.0 percent in 2017. 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.

In addition, the July announcement set a condition of requiring ‘‘some further improvement in the labor market.” From May through July, non-farm payroll employment gains have averaged 235,000 per month. In the case of the core rate of inflation, we are mainly looking for a good indicator of future inflation, and for better indicators than we have at present.

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. Among the many papers finding a role for resource utilization in affecting inflation based on evidence from macroeconomic time-series data, see Robert J. There has also been debate regarding other potential channels through which global factors could affect domestic inflation– for example, whether measures of foreign resource utilization play an important independent role. For evidence supporting such global factors, see Claudio Borio and Andrew Filardo (2007), “Globalisation and Inflation: New Cross-Country Evidence on the Global Determinants of Domestic Inflation (PDF),” Leaving the Board BIS Working Papers 227 (Basel, Switzerland: Bank for International Settlements, May).

This model incorporates monetary policy responses to economic shocks and thus may show smaller effects on real GDP and inflation than other partial-equilibrium analyses. It is noteworthy that in several inflation-targeting economies, the ten year expected inflation rate has settled precisely at the target inflation rate.

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