MNI INTERVIEW:Infl Expctns Likely Hovering at 2%-Fed Economist

By Sara Haire 
–Inflation Driven By Inflation Expectations "Difficult" To Prove
–Possible There Could Be Downshift in Consumers’ Inflation Expectations

WASHINGTON (MNI) – Concerns over the impact that inflation expectations have on actual inflation have been ramped up by some economists recently as expectation measures have converged closer to 2%, but in an interview with MNI, Cleveland Fed senior vice president and research economist Edward Knotek said that there could be a number of reasons why expectations have shifted and that there is no proven consensus on whether inflation expectations drive actual inflation–or vice-versa.

Some economists have voiced concern after a few inflation expectation measures have declined in the last few years, fearing inflation expectations could "unanchor" if there are continued gradual interest rate increases before inflation has been sustained at the Fed’s 2% symmetric objective. At the same time, a few other inflation measures have risen in recent months to eclipse the 2% threshold.

As Knotek pointed out, most economists would believe that short-term rises in inflation "would be somewhat tamped down by business cycle factors and/or monetary policy aggressively responding to that, which would bring it back to the long-run target."

Knotek mused that shifts in the measures could either be from a removal of bias from the data, or a "substantive downshift in trend from consumers responding," which would be considered "even more nefarious." However, despite these declines in some measures, inflation expectations appear to be inching closer to intersecting at or above 2%.

The minutes from the May 1-2 Federal Open Market Committee meeting affirmed that that there would not be an overreaction to inflation data modestly overshooting the 2% target and that it instead "could be helpful in anchoring longer-run inflation expectations."

–INFLATION EXPECTATIONS INTERSECT

Fears about inflation "unanchoring," should be put on the back-burner for now given survey, market, and model-based measures are hovering at the 2% trend, if not above it.

The Michigan Survey of Consumer Sentiment inflation expectations "has been coming down," Knotek said, however expectations still remain above the 2% trend, while business inflation expectations, as measured by the Atlanta Federal Reserve Bank, found expectations for the 5-10 year horizon remain below levels seen five years ago.

Market-based measures of inflation, such as the five and ten-year breakeven inflation rates, have recently risen, hitting slightly above 2%, but still have not broken the highs seen in 2014.

Conversely, the Cleveland Federal Reserve Bank publishes a model for the 10-year inflation expectation that recently reached a high since April 2010, climbing to 2.09%. This model uses Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation to find what the expected inflation rate will be.

Careful to not be reactionary, the Survey of Professional Forecasters has shown in the last five years that 10-year PCE inflation expectations have been relatively stable, hovering at 2% with little variation in the data.

–CHICKEN OR EGG

Recent research suggests that inflation data could be shaped by the expectations for where inflation is headed, suggesting that the need to keep expectations at around 2% is pivotal to make sure inflation is maintained at the FOMC’s symmetric objective in the near-term.

However, the question of whether inflation drives inflation expectations or vice versa is "a very difficult issue to disentangle" with no real right answer yet, Knotek explained.

Knotek noted that developments in the economy force models to evolve and is likely to shift the way in which inflation expectations are measured in the future, which could eventually account for possible downshifts in consumers’ expectations or a removal of an upward bias.

 

 

 

Ashley Joye Managing Partner T +44 (0)20 7422 2975 M +44 (0)7796 308 391 E ashley.joye@archr.com 49 Carnaby Street, London, W1F 9PY United Kingdom ARCHR.COM