The FOMC median inflation projections are likely, once again, underestimating future inflation. But less obviously true than their previous projections.
They expect PCE / core PCE inflation to be 4.2% / 3.7% this year. To hit that would require a large inflation slowdown.
In the first 8 months of the year (including a reasonable forecast for Aug based on the CPI & PPI), inflation rose at around a 5% annual rate. To hit their numbers for the full year will require it to slow to about a 1.5% annual rate. In other words, 0.12% monthly prints.
That could happen if either a lot of transitory level increases reverse themselves (e.g., used car prices will likely fall more) or if there are transitory falls due to spreading virus (e.g., further falls in travel/tourism prices).
But I would take the over on any forecast of 0.11% monthly prints in September, October, November and December given momentum and expectations, places where prices have risen a lot yet and sectors like shelter (smaller in PCE than CPI but non trivial).
Notably, the FOMC's inflation projections for 2021 have risen a lot (not surprising given effectively eight months of data) but have only risen a little for 2022. That means they don't think price levels will fall back but also don't think momentum will carry forward.
I have a much wider confidence interval for 2022 but I view 3% as much, much more likely than 1% and would not hesitate to take the over on their 2.3% forecast at even odds.
(BTW, note the FOMC median forecast has the property that many forecasts have which is that inflation slows down a lot to about 0.10% monthly prints before rising again to 0.20% monthly prints. Is broadly believed that we'll have an inflation lull before it picks up again.)
The question remains if (as I view more likely than not) inflation is above their expectation what does that do to their interest rate path? If you think inflation is going to be 2.3 / 2.2 / 2.1 then you can focus on employment, but if that doesn't happen then what?
I continue to think the Fed should raise its inflation target to 2-3 percent or 3 percent. But if they don't do that the consistent predictions that an inflation slowdown is right around the corner will eventually start to cause problems if they keep being wrong.
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Jeremy Rudd has a paper on inflation expectations that is well worth reading if you're interested in this topic. Takeaways: (1) don't be reassured by anchored expectations & (2) be worried if people start noticing actual inflation.
1. I agree with Jeremy that inflation expectations risk being a residual term that make models work perfectly, that much casual economic conversation has that feature, but they also can be effectively operationalized so wouldn't ditch them entirely.
2. His argument goes against relying on measures like the Index of Common Inflation Expectations (CIE) to argue that Flexible Average Inflation Targeting (FAIT) is working. It takes away the dovish argument, "sure inflation is up but don't worry, expectations are anchored."
FISCAL DOMINANCE is massively overstated as a motivation or risk for the Fed.
FINANCIAL DOMINANCE is greatly overstated as a motivation or risk for the Fed.
Understanding the actual Fed the issue is really about EMPLOYMENT DOMINANCE, and that is more good than bad. A 🧵:
1. Fiscal dominance says the Central Bank deliberately keeps interest rates lower than it would otherwise in order to prevent the government's debt from growing too fast. With debt much higher than in the past they have the motive, so the argument goes, to keep rates low.
Most serious people think we don't have fiscal dominance now but some worry that we'll have it in the future if there is a less responsible Fed Chair or President. I think this misunderstands both the White House's interests and the Fed's actual behavior.
Unsure whether @JayCShambaugh's arguments get to the actual number. I was focused on the $32b increase from 2020-H2 to 2021-H1. That is when we saw the massive divergence in US & world fiscal policy and also a divergence in growth, the opposite of the recession in his 1st point.
I would think if we used your estimates to calibrate the impact of fiscal stimulus we would have predicted a much larger current account move, almost certainly relative to last yr and likely for 2021 relative to 2019 too (the ~$280b annual rate you note). aeaweb.org/articles?id=10…
The House bill doubles cigarette taxes from $1/pack to $2/pack and raises other tobacco taxes. The direct effect of this is regressive but the indirect effects are much larger, more important and very progressive--conferring larger health gains for lower-income households. A 🧵.
I addressed this issue in a speech I gave when I was at CEA arguing that the tobacco taxes disproportionately benefit lower-income households.
To fully analyze it we need to understand four components:
1. The direct effect. This is regressive because lower-income people smoke more and thus end up paying more in taxes.
(Technical aside: The incidence of the tax is likely partly but not fully on consumers because contrary to conventional wisdom demand is not inelastic.)
Retail sales out this morning (I'm a bit late to it). Surprisingly strong:
--Nominal sales up 0.7% (that's A LOT for a single month, especially when they were already well above trend).
--Spending at restaurants and bars was flat in August and 1.4% higher than June.
Stepping back for the bigger picture, nominal retail sales are 14% above trend. The majority of that is prices but the quantity (real retail sales) is still 6% above trend.
Reminder: these data are ~half of consumption & are miss most services, which are still below trend.
The huge spending bump on cars and parts is now over and instead we're just left with a large spending bump. But that spending bump is all to cover the higher prices, adjusted for inflation they are lower than they were pre-pandemic. Is the opposite of pent-up demand.
August CPI is out, most benign headline reading since January... but in a reversal from previous months the underlying trends were somewhat worse than the headline.
The underlying trend many have focused on was about the same as previous months.
In August some of the temporary factors driving up inflation went into reverse either because they had overshot the mark (used car prices -1.5% in Aug & car and truck rental -8.5%) or because the delta resurgence temporarily dampened prices (airlines -9.1% & hotels -3.3%).
Inflation from February to July was extraordinarily high: core CPI rose at an 8.0% annual rate. We always knew that inflation would not continue at an 8.0% annual rate. The question is will it slow to something like 2% (the Fed's view) or something meaningfully higher (my view).