My expectations for moderating inflation and limited spillover effects from commodity price increases depend critically on the continued stability of inflation expectations.

The FOMC has never wavered on this all important aspect of monetary policy – they firmly believe inflation expectations are what causes a relative value story to turn into an inflation story.

In that regard, year-ahead inflation expectations of households have increased this year in response to the jump in headline inflation. Of greater concern, some measures of longer-term inflation expectations appear to have edged up. If longer-term inflation expectations were to become unmoored–whether because of a protracted period of elevated headline inflation or because the public misinterpreted the recent substantial policy easing as suggesting that monetary policy makers had a greater tolerance for inflation than previously thought–then I believe that we would be facing a more serious situation.

If inflation expectations come unmoored for any reason, inflation is thought to follow.

And here he expresses concern that inflation expectations may be rising due to a public perception that the Fed easings mean the Fed has a greater inflation tolerance.

Governor Kohn is clearly concerned that the Fed’s actions since August may be causing inflation expectations to elevate, and his statement further implies that it will take actual ‘action’ on the part of the Fed to dispel the notion that they are more tolerant of inflation.

Markets will not believe the Fed will take action on inflation until after they actually do it, but that the Fed will respond to weakness regardless of inflation. This was expressed by today’s price action. With crude hitting $129 EDs a year out are 8 bps lower in yield.

4 Responses

  1. From a consumer viewpoint, the rising price of energy products (gasoline, heating oil, etc.) and increases in food prices are what drive inflation expectations. Why does the fed persist in thinking this is a perception game based on their monetary policy? For average Americans, this means nothing to them. What mom and pop America see, and what they care about, is that the cost of gasoline is rising and the cost of basic food like milk, cheese, and grains is going up. And, these are the factors that drive their inflation expectations.

    Why is the fed so out of touch with the reality of what drives consumer sentiment? My own perceptions of inflation are driven by facts… as are (I suspect) those of many other American familes. And, the basic fact I observe day in and day out is this: increases in consumer prices for basic commodities are outpacing the fed’s inflation estimates by a wide margin.

    My point is that the fed just doesn’t seem to ‘get it’. There is nothing perceptual about this – I and other American consumers know how much a gallon of milk costs us. We know how much a loaf of bread is. We know ho much gasoline costs The fed seems out of touch with hat really drives inflation expectations.

  2. The Fed does recognize gasoline prices as a leading cause of inflation expectations (as measured).

    What is interesting is that they now seem to also be considering the possiblity that their interest rate cuts over the last several months have signaled to the markets that their tolerance for inflation has gone up.

    so seems this combo of both prices going up and the fed acting as if they are ok with that is of immediate concern for the fed.

    they have been watching to see if the ‘relative value story’ of food/crude/imports going up shows signs of turning into an ‘inflation story’ via rising inflation expectations.

    they are now very concerned that this is indeed happening, and partly due to how the markets have interpreted their actions over the last several months.

    it is this type of thing that adds urgency to the hawk camp within the fed to get the ‘real’ rate back to and beyond ‘neutral’ asap.

  3. In the Fed minutes released today, there was a statement about
    expecting unemployment to rise and weaker than previously thought economic performance. Given this slack in the economy, wouldn’t they continue to expect inflation to moderate and thus not need to hike immediately.

  4. Maybe, but they’ve also lost all confidence in their ability to forecast crude prices, inflation expectations are rising, and they expect modest improvement in an economy that may be weak but is strong enough to be supporting ever higher prices

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