Could Federal Reserve’s disagreement over inflation forecast signal higher inflation in the future?

The minutes for the Federal Reserve’s December meeting indicates that November’s debate over inflation and inflation expectations continues.

For example, staff at the Federal Reserve continue to forecast a very tame pricing environment:

“The staff forecast for inflation was nearly unchanged. The staff interpreted the increases in prices of energy and nonmarket services that recently boosted consumer price inflation as largely transitory. Although the projected degree of slack in resource utilization over the next two years was a little lower than shown in the previous staff forecast, it was still quite substantial. Thus, the staff continued to project that core inflation would slow somewhat from its current pace over the next two years. Moreover, the staff expected that headline consumer price inflation would decline to about the same rate as core inflation in 2010 and 2011.”

But, on balance, the members of the Fed still disagree about the future risks of inflation:

“Some noted the risk that, over the next couple of years, inflation could edge further below the rates they judged most consistent with the Federal Reserve’s dual mandate for maximum employment and price stability; others saw inflation risks as tilted toward the upside in the medium term.”

The concerns of the “inflation hawks” are familiar:

“Participants noted that any tendency for dollar depreciation to put significant upward pressure on inflation would bear close watching.”

“Some participants noted, however, that rising prices of oil and other commodities, along with increases in import prices, could boost inflation pressures going forward.”

“A few participants noted that banks might seek, as the economy improves, to reduce their excess reserves quickly and substantially by purchasing securities or by easing credit standards and expanding their lending. A rapid shift, if not offset by Federal Reserve actions, could give excessive impetus to spending and potentially result in expected and actual inflation higher than would be consistent with price stability.”

In response to this debate, Reuters quoted an interesting perspective from St Louis Fed economist Kevin Kliesen:

“Kliesen suggested disagreement on the inflation outlook could provide some insight into what lies ahead, noting that past five-year forecasts of the average Consumer Price Index inflation rate from Blue Chip Economic Indicators show that when inflation was relatively high and variable, such as the late 1980s and early 1990s, there was sizable disagreement among forecasters about the medium-term inflation outlook.

By contrast, during periods when inflation tends to be relatively low and stable, such as the mid-1990s to mid-2000s, forecasters tend to disagree less about the… outlook.”

Perhaps disagreement leads to inaction, and the inaction becomes crippling when inflationary pressures finally surface. Even as the Federal Reserve takes initial steps preparing for the day it must drain liquidity from the economy, this “disagreement dynamic” deserves watching over the coming months.


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