The Unmooring of Inflation Expectations
It’s been so long since our last bout with entrenched inflation that many, if not most, Americans including policy makers and central bankers, have likely forgotten how inflation expectations become “unmoored” and what that truly means for the fight ahead.
Recently, Federal Reserve of St. Louis president James Bullard addressed current inflation and the potential downside risk:
“The current U.S. macroeconomic situation is straining the Fed’s credibility with respect to its inflation target,” Bullard said.
Bullard noted that, in the past year, near-term inflation expectations of financial markets, households and businesses have risen. He added that the current divergence between actual inflation readings and expected inflation based on Treasury Inflation-Protected Securities will have to be resolved, possibly resulting in still higher inflation expectations.
“In the 1970s, inflation expectations became unmoored, and it took years for the Fed to bring inflation back to lower levels. The real economy was also volatile during this process,” Bullard said.
Like a ship adrift on the open ocean, once inflation expectations have become “unmoored”, the population’s concern for inflation is free to float off aimlessly into the distance getting ever further from where it was once very stably anchored.
Then once blown about by the epic squall of emerging economic headwinds, re-anchoring inflation is no small task given the momentum it gains and the forces and erratic volatility that comes of it once it really starts to run wild.
At this point, I believe that it’s safe to say that the Fed has fully lost the narrative.
Everywhere you go people are talking about inflation in one form or another; rising gas prices, food prices, new car availability and prices, used cars availability and prices, outlandish home sales bringing stunning bidding wars with $200K, $300K and even $500K over-list contests. The effects of hot money appear to be everywhere!
It’s starting to really interfere with the normal operations too, as was well testified by a totally unsolicited discussion I recently had with an older, local restaurateur. He seemed simply in pain as he recounted how difficult times have gotten. After over two years of struggling to keep his business afloat throughout the pandemic, now he is stretched to the absolute limit by increasing prices. My bill too, as it was easily up 30-40% over what I paid just about a year ago.
But this small anecdote pales in comparison to the damage done by the Fed’s inaction and the administration’s totally incompetent and confused approach to “leadership”.
The Fed’s insistence that inflation was “transitory” only to be forced to walk back that terminology back and pivot to a more nuanced language about Ukraine, China lockdown supply chain issues and ongoing COVID disruptions that only imply “transitory” represents a completely misjudged or misguided approach to managing market expectations.
Either the Fed does not understand that the inflation we are seeing today is general monetary inflation coming as the result of over 13 years of recklessly easy monetary policy (QE, ZIRP) and still believes that the current exogenous events are causing it or they fully understand the truth but are simply unwilling to indicate so publicly.
In the latter case, the Fed would have been wiser to have at least indicated early on that monetary inflation could be responsible while also citing the other causes that they preferred it be rather than going all in on exogenous “transitory” sources only to look completely out of touch once inflation persisted further than “transitory” could have ever implied.
Amazingly though, Powell and the other members of the FOMC have not appeared to have learned from this mistake, indicating yesterday that:
The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.
Again, they are essentially doubling down on “transitory” by placing such an emphasis on temporary conditions being the source of the persistent inflation while only vaguely implying that there is some other source by stating “creating additional upward pressure”… additional to what?
The “what” is exactly what they apparently do not want to discuss too openly, namely general monetary inflation that they themselves (including former Chair now Treasury Secretary Yellen) created in their effort to act as the apex-lender-of-last-resort after the Great Recession and ongoing to today.
By not being forthright about the cause of inflation, they will continue to appear hopelessly out of touch and uninformed, exactly the opposite of what is needed in order to truly regain the confidence of the markets.
The administration, on the other hand, has been nothing short of a total disaster attempting to control the inflation narrative like they would any purely partisan political issue.
Whether it’s an appearance on popular late night television or various inflation-themed photo ops, the administration appears to believe that you can just talk inflation down by assuring the public that the executive “feels their pain”, but this is absolutely the wrong approach.
Like the Ford’s absurd “Whip Inflation Now” campaign or Carter’s sad and depressing fireside chats, trying to control inflation by simply messaging (regardless of the message) the public directly, is counterproductive at best.
What the public needs to see in order to be convinced that the administration is on the right track in the battle with inflation is simply one thing, action.
This can come in many forms; a call for Congress to tighten the budget to avoid further deficits, reopening or expanding cancelled or stalled energy sources (pipeline, coal, gulf rig counts, Anwar oil fields, etc.), working to smooth disruptions in global trade and supply, negotiating new agreements with other trading partners, eliminating any vestige of pandemic related encumbrances.
But our current administration is missing this point entirely and thereby squandering this very brief moment where the inflation story is still not deeply ingrained within the American collective psyche.
Taken together, the Fed’s mischaracterization of the source of the inflation and the administration’s lack of leadership is currently working to seriously undermine confidence, thereby sowing the seeds of a prolonged bout of persistent entrenched inflation as the public learns to expect ever-present uncertainly, volatility, cost pressures and a lack of vision from the authorities tasked with leading the way out of this difficult period.