The Fed Is Negotiating With Itself on Inflation
(Bloomberg Opinion) -- If you’re worried about the recent surge in inflation, some reflection on the past decade might prove useful therapy. Central banks are willing to look beyond price spikes they consider transitory, in large part because of a perceived need to atone for missteps after the last big slump.
It's hard to understand why the Federal Reserve appears unfazed without appreciating how much past forecasting errors weigh on policy deliberations. In recent years, global monetary chiefs have misread signals time and again. They were willing to withdraw stimulus and raise interest rates because projections told them higher inflation loomed. But it never really showed up. Officials are now haunted by that failure. And for those who urged the Fed to pare stimulus in the aftermath of the global financial crisis for fear of rampant price increases and so-called dollar debasement, some penance is also in order. That phenomenon didn’t pan out, either.
So, who’s right — the hawks, who say this time is different, or more dovish officials, who see what's happening now as a healthy correction from very low levels recorded during the early months of the pandemic? The onus must be on the former to prove their case, given they cried wolf before. Implicit in their fear is the idea that the forces holding inflation down in recent decades are over, and all that matters is the cavalcade of price gains unleashed by what’s anticipated to be strongest U.S. bounce since 1984.
Folks at the Fed sound skeptical. Inflation “is likely to be meaningfully above 2% over the forecast horizon,” Federal Reserve Bank of St. Louis President James Bullard said recently. “This would be a welcome development for the [Federal Open Market Committee], as inflation has generally been below target for many years.” Worrywarts got ammunition last week with figures showing U.S. consumer prices climbed the most since 2009 and producer prices picked up. Markets for commodities from copper to lumber and corn are booming.
This isn't just an American story. Signs of rapid recovery in South Korea have prompted traders to bet on early rate hikes, encouraged by strong growth and a spurt in consumer inflation. Such thinking is premature, a state-funded think tank concluded last week. An improving global economy and rising oil prices will temporarily add upward pressure on headline inflation, but the country’s core gauge, which better reflects domestic demand, remains below the 2% target “by a large margin,” the Korea Development Institute said Thursday.
Few expect the Fed to raise its benchmark rate next year, but investors are scratching about for signs that policy makers will begin a discussion about tapering. That’s unlikely before September. Officials are careful to add that if things do go awry, they won't hesitate to act. When the central bank paused a series of rate hikes in early 2019, speculation immediately began that the next move would be a cut, something authorities took pains to discourage. By late July, rates were coming down. And who can forget the insistence from Fed and Treasury officials in 2007 that problems in the housing market were “contained”?
A climbdown by the Fed, and its peers abroad, would be more jarring today, in part because their language about holding the line has been so insistent. The central bank only last year completed a strategy review that was more than a year in the making and ostensibly designed to address the shortcomings of past cycles. Officials would now aim for an average of 2% over time, including some overshooting for past misses. The European Central Bank is reconsidering its own approach with a review likely to wrap up later this year.
Backing down now would mean that the last war isn't worth re-fighting and that the Fed strategy review had little conviction. “We see central banks aiming for higher but not high inflation,” wrote JPMorgan Chase & Co. economists Bruce Kasman and Joseph Lupton, in a May 12 note.
The coming months will test policy makers’ mettle. At least until the next crisis.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.
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