Thursday, March 19, 2015

Is 2% core inflation the Fed's target, or a ceiling?

 - by New Deal democrat

I really don't have much to add to what you have probably read elsewhere about the Federal Reserve's policy statement, except that it appears to me that 2% inflation isn't really being treated as a target so much as a ceiling.

Their estimate of NAIRU has declined to 5% - 5.2% unemployment, which is an acceptance of  the reality that there is zero pressure on inflation from wage growth at this point, and likely won't be for awhile.

All well and good, but here is the Fed's high end estimates for inflation for this year and the next two years:

Core inflation
2015 1.4%
2016 1.8%
2017 2.0%

The Fed doesn't expect core inflation to hit their 2% target for two years!  Yet here is what they say:
[T]he Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of energy price declines and other factors dissipate..
....  In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. ...  The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term
Since lower gas prices are likely to cause core inflation to slightly decrease over the next year as they feed through into the broader economy, it will take well over a year for such factors to "dissipate."  But the Fed is going to raise rates in advance of 2% YoY core inflation, to ensure it does not exceed that level.

In practice that's a ceiling, not a target.