Laurence Meyer confident in Fed’s ability to respond to an increase in inflation expectationsPosted: March 28, 2011
Laurence H. Meyer, a former governor of the Federal Reserve, wrote an op-ed in the New York Times titled “Inflated Worries” in which he confidently argues that inflation expectations remain well-contained and even if they became unhinged, the Federal Reserve is ready to respond quickly:
“The Fed, this argument goes, just won’t be able to act quickly enough to turn off the spigot when the time comes to do so.
But the Fed can raise interest rates directly any time it wants. In addition, it could start to sell the huge volume of Treasury securities and other financial assets on its books, which would also place upward pressure on rates.
Would the Fed act in time? I expect that it will. And even if it doesn’t act in time, and inflation expectations start to get out of line, I am confident that the Fed would tighten monetary policy quickly and aggressively enough to restore price stability and maintain its credibility on inflation. You can take that to the bank.”
Meyer’s unspoken assumption in this piece is that unemployment would not be so high that it discourages the Federal Reserve from acting. Ben Bernanke has made it abundantly clear that unemployment is front and center and that the growing concerns about inflation around the globe are not his or America’s concern. So, I remain extremely doubtful that the Federal Reserve is unconditionally prepared to act in the face of rising inflation expectations.
Meyer also explains in his piece the difference between core and non-core (or headline inflation). He disabuses the audience of the notion that higher food and energy prices increase inflation expectations citing Federal Reserve research that “…unequivocally tell us that core inflation better predicts overall inflation tomorrow” (see “Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices“). However, Meyer blithely ignores the study’s conclusion that this relationship did NOT hold during the 1970s and 1980s: “In the 1970s and early 1980s, movements in overall prices and prices excluding food and energy prices both contained information about the trend.” In other words, there is little in this study to suggest that the relationships are stable.
Ultimately, I think those who argue that there are fundamental, structural pressures that indicate increasing energy and food prices are reflective of inflation’s future direction, especially once supply constraints finally show up in more sectors of the economy, will prove to be the most prepared for the future. In other words, today’s food and energy inflation has been an early outcome of easy money policies because supply constraints and demand dynamics are most readily exploited in these sectors of the global economy right now. (I made a related argument when discussing the recent rapid increase in coffee prices).
Hopefully through inflation watch you have been able to note the growing pockets of inflation pressure and the increasing power companies have to raise prices at least at the producer level…