On Wednesday, the five-year inflation rate fell to 2.48%. If that doesn’t tell you anything—and it’s perfectly justifiable if you’re not a professional economic observer—try this: The wholesale price of gasoline is down about 20 cents a liter from its peak a month ago. At the moment, only a small part of this reduction has reached consumers, but in the coming weeks we are likely to find significant price drops at gas stations. Coincidentally: How likely is a drop in the price of gasoline to get even a small part of the media attention to the rally?
What these numbers indicate, as well as the growing accumulation of other data, from rents to transportation costs, is that the risk of stagflation is receding. This is good news, but I worry that policymakers, especially those at the Federal Reserve, will be slow to adapt to the new information. They were obviously very complacent (as was I) about the risks of rising inflation, but now they may become more attached to a tight money-control stance and cause an unexplained recession.
Let’s talk about what the Federal Reserve is afraid of. Obviously, we’ve had serious problems with inflation over the past year and a half. Much of that inflation — perhaps most of it — appears to have been a reflection of temporary supply shocks ranging from supply chain problems to the Russian invasion of Ukraine. But another aspect also reflects the warming of the economy. Even those of us who consider money pigeons agree that the Federal Reserve should raise interest rates to cool the economy, as it did. This increase, along with the expectation of more in the future, has caused interest rates that matter to the real economy to rise – especially on mortgages – which will reduce spending across the board. In fact, there are already signs of a major economic slowdown.
But the minutes of last month’s meeting of the Federal Reserve’s Open Market Committee, which sets interest rates, indicate significant concerns that simply cooling the economy will not be enough, that expectations for future inflation are “uncorrelated”, and that price hikes “may take hold”. In principle, these are not absurd concerns. Throughout the 1970s, almost everyone came to an expectation that high inflation would be a persistent phenomenon, and this expectation was built into the determination of wages and prices. For example, employers were willing to create salary increases of 10% per year because they expected all of their competitors to do the same. To cleanse the economy of these entrenched expectations requires a prolonged period of extremely high unemployment: stagflation.
But what could make the Federal Reserve believe that something similar is happening now? Both the institution’s minutes and comments from its president, Jerome Powell, indicate that an important factor was the initial publication of the results of the University of Michigan survey, which appeared to show a rebound in long-term inflation expectations. Even then, some of us warned against giving too much weight to one person, especially since others didn’t say the same. To be sure, the accident in Michigan was a passing accident; Most of that sharp rise in inflation expectations disappeared when the revised data was released a week later.
And for what it’s worth, financial markets are more or less sounding the alarm about persistent inflation. The implicit five-year rate is the difference between ordinary interest rates and those on rate-protected bonds; Thus, it is an implicit expectation of future inflation. A closer look at the markets not only shows that they expect relatively low inflation in the medium term, but they also expect it to decline more or less after next year and then return to a level consistent with the long-term target. Federal Reserve max.
To be fair, bond traders do not set wages and prices, and in principle, inflation may take root in the minds of workers and companies, even if investors decide it is under control. But it is unlikely. Also, this could be a kind of self-destructive prophecy, as investors are lowering their expectations for future inflation precisely because they expect the Fed to hit the brakes hard. However, it is disconcerting to read reports that the Fed is taking a tougher stance, even as the economy weakens and expectations for persistent inflation wan.
I don’t know exactly what is going on. Part of it may be the very broad tendency among policymakers to insist on a course of action even when the facts do not support it. It may be partly because, having erred about inflation in the past, that Fed officials, perhaps inadvertently, are prone to bullying from the Wall Street types bent on hysteria about future inflation. They may have gone too far to compensate for the earlier downplaying of inflation risks.
Anyway, there is an old joke that says a motorist hits pedestrians and then tries to remedy the accident by backing up, at which point he hits him again. I fear something like this could happen in monetary policy.
Paul Krugman He is a Nobel Prize winner in economics. © The New York Times, 2022. Translate news clips
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