4 Reasons Inflation Is Too Low
(Originally published here.)
Worried about inflation? Then you probably think that prices are rising too quickly. But there's a monetary policymaker -- James Bullard, the president the Federal Reserve Bank of St. Louis -- who has the opposite concern.
Bullard fears that inflation is too low. So much so, in fact, that he dissented in today's monetary policy announcement from the Federal Open Market Committee. Bullard believes that "the committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings," according to the press release.
Prices have risen 0.7 percent over the last year as measured by the index tracking personal consumption expenditures, the Fed's preferred measure of inflation. The rate of inflation has been below target and generally falling since last April. The central bank has an annual inflation target of 2 percent.
If inflation is so far below the Fed target, why is this not more of an issue? The rest of the monetary committee answered that question with a change to their policy statement: "Partly reflecting transitory influences, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable."
Let's take this out of Fedspeak. "Transitory influences" are usually changes in prices of food and gasoline, which tend to be volatile. The Fed recognizes that inflation is below target. But it's okay, they say, because investors and businesses trust them to hit 2 percent inflation eventually.
This is wrong on several counts. Bullard, the lone dovish dissenter at this meeting, is right.
1. The Fed's own projections anticipate that inflation will stay below 2 percent through the end of 2015. Its best guess for inflation this year is just 1 percent. If such expectations become reality, it would mean that in the time since the Fed has adopted its inflation target, inflation has been above the target for three months and below it for 45 consecutive months.
2. It's not clear that inflation expectations remain anchored at 2 percent. Several different measures exist, but one compiled by the Federal Reserve Bank of Cleveland finds that inflation will remain below 2 percent through the "forecast horizon" of 30 years.
3. The Fed mischaracterizes what's driving lower inflation. It's not "transitory influences." That's what core inflation, which excludes food and energy prices and now stands at a 50-year low, is telling us. Another way to see this is in how broadly inflation is falling. The Bureau of Economic Analysis divides personal consumption into 19 sectors -- categories such as "housing and utilities" and "clothing and footwear." Inflation has slowed in 16 of these categories since last year. That's the broadest disinflation since the late 1990s.
4. It's worth asking why monetary policymakers are shooting for just 2-percent inflation at this moment. The Fed has a dual mandate: It's supposed to be thinking about unemployment, too. Keeping these two in balance, as Minneapolis Fed President Narayana Kocherlakota haswritten, would mean tolerating temporarily above-target inflation to help unemployment fall more quickly. Instead, the Fed has chosen to let unemployment fall slowly so that inflation never breaches the target.
The chat in markets is now all about "tapering," or the gradual exit of monetary easing. That's a mistake. The Fed still hasn't finished the job it gave itself.