Fed official: Don’t underestimate the risk of inflation

In a presentation to an economics conference yesterday, St. Louis Federal Reserve President James Bullard said that medium-term inflation risks are higher than many forecasters believe:

“I am concerned about a popular narrative in use today — the narrative being that the output gap must be large since the recession is so severe,” he said. “And so, any medium-term inflation threat is negligible, even in the face of extraordinarily accommodative monetary policy. I think this narrative overplays the output gap story.”

He said calculations aimed at measuring the output gap do not take asset price bubbles into consideration, so if much of the current drop in output was tied to the bursting of the housing bubble, “then today’s output gap would be smaller than it appears,” which would mean a higher risk of inflation.

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