Federal Reserve Chairman Jerome Powell says controlling inflation expectations is key to achieving the central bank’s twin goals of price stability and maximum employment.
The trouble is that it is far from clear the Fed can do that as the economy emerges from the pandemic. Expectations among consumers can vary widely, depending on their age and gender—and are not particularly sensitive to what the central bank does and says.
What’s more, the attitudes of businesses—arguably the most important players in the inflation process because they set prices—are a bit of a mystery because there are few surveys of their thinking on the subject.
“It certainly is difficult” to manage expectations, said former Fed Governor Randall Kroszner, who’s now a University of Chicago professor. “Especially when you don’t know exactly how to do it.”
Policy makers don’t want inflation fears to get out of control in part because of the danger that then leads to a self-fulfilling prophecy. Concerns about such a dynamic taking hold have been triggered by the acceleration in prices in recent months.
The shifts have seen Powell and his colleagues do a complete turnabout when it comes to trying to shape Americans’ inflation beliefs. At last August’s virtual Jackson Hole meeting, the Fed chief unveiled a new monetary framework aimed at preventing inflation expectations from falling too low, by deliberately seeking price rises above the Fed’s 2% target for a time.
Now, the central bank’s focus has shifted to trying to stop inflation concerns from spiraling after a 3.9% annual surge in prices in May and a jump in consumer expectations to their highest level since 2013 in a monthly New York Fed survey.
Powell argues that the steep price rises will prove to be largely transitory and that expectations on the whole are where the Fed wants them. Longer-term projections have risen to “a range that’s consistent with what our objectives are,” he told reporters on June 16 after policy makers unexpectedly penciled in two increases in interest rates in 2023 from their current setting near zero.
‘Biggest Risk’
Some economists have played down the significance of shifts in expectations, arguing that there is little evidence since the 1980s that they’ve led to changes to behaviour and to actual inflation.
Kroszner, nevertheless, is worried.
“We have the biggest risk of inflation expectations becoming unanchored and moving up in the last couple of decades,” he said, while stressing that he doesn’t see a high probability of that happening.
The Fed’s attempt to fine-tune expectations is complicated by the different prisms through which consumers view price pressures.
“People who lived through high inflation have systematically higher inflation expectations, and a stronger dislike for inflation, than people who did not have this experience,” academic economists Olivier Coibion, Yuriy Gorodnichenko, Saten Kumar, and Mathieu Pedemonte wrote in a 2018 paper.
That showed through in the latest New York Fed survey. Consumers 60 years of age and older—who lived through the inflationary 1970s—had markedly higher expectations than those under 40, who’ve only known low and stable prices.