Slowdown in Core Inflation Remains the Focus

For a while now—in particular, since the September FOMC meeting—there’s been a clear consensus on the  FOMC for hiking at the December meeting. Now that decision is certain, given that policymakers’ public remarks in the period since the October/November FOMC meeting did not indicate any change in that consensus. With the labor market has continued to improve and growth surprising to the upside,  policymakers felt another hike would be appropriate, especially considering how accommodative financial conditions remain. However, the single biggest issue with respect to monetary policy remains the inflation outlook. In particular, most policymakers still consider it a mystery why core inflation slowed this year, and many signaled that a firming in core inflation will be required for them to support continued tightening in  2018. 

Views on the slowdown in inflation varied substantially, but most continued to think of it as a “conundrum”  (Harker, 11/12). For some participants, their greatest concerns centered on the possibility of a decline in inflation expectations. In this case, weak inflation would be more persistent. Evans (11/15) said that “With  each low monthly reading, it gets harder and harder for me to feel comfortable with the idea that the step 

down last spring was simply transitory.” He felt that “something more persistent is holding down inflation today…namely, I feel we are facing below-target inflation expectations.” He suggested “we could go below  4 percent” unemployment and thought inflation should be allowed to go above two percent since the objective is supposed to be symmetric. Late in the intermeeting period, Evans (12/6) spoke out quite strongly against further raising rates until the inflation outlook firmed and inflation expectations were in line with the objective.  These comments lead us to believe that he, in addition to Kashkari, is likely to dissent at this week’s meeting.  Bullard (11/14) likewise cited the possibility of low inflation expectations as the reason for his continued support for the accommodative policy. However, he seemed to accept a December hike despite his concerns:  “I’ve said that I’m willing to go with the data, and growth prospects have been better this fall” (11/10). Like many of his colleagues, especially those on the more dovish side of the center, he noted that the Phillips curve link between inflation and slack is weaker, and also that the low participation rate suggests slack may remain  (11/10). Yellen made some public remarks since the last FOMC meeting, continuing to discuss the issues facing monetary policymakers in an evenhanded manner. She emphasized that “it can be quite dangerous to allow inflation to drift down and not to achieve over time a central bank’s inflation target,” but maintained that she doesn’t “really think [inflation expectations have] drifted down very much” (11/22). 

Williams provided a take on inflation dynamics that contrasted with the usual narratives presented by policymakers, in particular the story that the Phillips curve relationship between economic activity and inflation may be broken or very weak. To him, the “mystery” of stubbornly low inflation “isn’t all that mysterious after all” (11/29). In particular, he cited research suggesting “inflation rates for prices that tend to move up and down with the economy have recovered. But inflation for things that tend to be less sensitive to the economy has fallen or remained low.” The latter category included pharmaceuticals, airline tickets, cell phones,  education, and healthcare. To him, the Phillips curve is alive and well, at least for those prices that historically have responded to slack. He also noted that “it typically takes about 12 months for a shift in the economy to have its full effect on inflation,” leading him to believe inflation would rise in 2018. 

The GOP’s tax legislation efforts progressed substantially, and rapidly, in the period since the last FOMC  meeting, and some policymakers commented on its implications. In the context of discussing fiscal stimulus,  Kaplan (11/17) noted that “the U.S. economy is approaching full employment,” implying that stimulus might warrant tighter policy than otherwise. He (11/30) said: “My concern is with other elements of this package  that are clearly a tax cut, short-term stimulus, which I think will create a little bit of a bump in GDP.” Dudley  (12/1) had strong words on Congress’s tax efforts, saying now is “probably not the best time” for fiscal  stimulus: “It would be a reasonable question to ask, is this the best time to apply a fiscal stimulus, when the  economy’s already close to full employment?” Bullard (11/14) seemed more receptive to the possibility of tax legislation than his colleagues, suggesting that it might constitute productivity-enhancing reform rather than mere short-term stimulus: “When productivity goes up, wages go up and everyone is happier. That is part of  the aim of the tax bill.” He later said, “Hopefully we can get some additional growth out of it. That would not  have any immediate implications for monetary policy in my view.” Of the tax legislation moving through  Congress, Mester (11/30) said, “I don’t believe what I see is going to have a major impact.” She elaborated:  “Most of the work I’ve seen about changes in the corporate tax rate doesn’t really support this big increase  that some people are predicting for potential growth.” Bullard (11/14) and Harker (11/13) noted that their projections did not incorporate fiscal stimulus; Williams (11/6) and Mester (11/30) said that theirs did. 

Harker (11/12) and Williams (11/9) identified themselves as seeing three rate hikes as likely to be appropriate in 2018, though Harker, in particular, was uneasy because of below-objective inflation. Harker (11/8) qualified  his support for a December hike, adding, “perhaps I should say, ‘lightly penciled in.’” Rosengren (11/15)  continued to argue that the FOMC should maintain a steady pace of rate hikes to avoid getting behind the curve. A failure to do so might result in a policy mistake, requiring the FOMC to raise rates faster and risking a recession. Softcore inflation might well be transitory, indeed, was expected to be, in contrast with the declines in the unemployment rate, which were widely seen as representative of a tightening labor market.  Mester (11/30) argued that accommodative financial conditions, including low long-term yields and elevated equity prices, were a reason “why we need to keep raising up the short rate. Of course, Powell was also officially nominated to be the next Fed Chair, and he also appeared before the  Senate Banking Committee for his confirmation hearing (11/28). He was well prepared and performed well,  avoiding answering questions about fiscal policy (link). While he noted that decisions are made by the entire  Committee at each meeting, his comments all but confirmed there would be a December hike. He said  “conditions are supportive” for a further rate hike, and he said, “I think that the case for raising interest rates at our next meeting is coming together. As expected, those policymakers who commented on his nomination spoke well of him. Kashkari said, “I think he’s a very serious, thoughtful policymaker. So I’m not anticipating  the transition from Chair Yellen to Chair Powell will lead to a big change in the way we conduct monetary  policy.” Williams noted that Powell represented “a nice combination of both strong consensus-building skills  and also will make sure that we’re moving ahead in the right direction.”

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