Thinking about the Outlook for Inflation GIC Central Banking Series Michael F. Bryan Federal Reserve Bank of Atlanta Vice President and Senior Economist
October 10, 2013 These views are mine alone, and do not necessarily reflect the views of the Federal Reserve Bank of Atlanta or the Federal Reserve Board.
An evaluation of the evolution of SEP (midpoint) growth forecasts indicates a clear, recent tendency to overestimate growth over the medium term. Real GDP growth projections for 2011, 2012, and 2013 were originally put near 4% when FOMC participants were looking out one to two years into the future. That optimism about the medium term ultimately gave way to realized growth nearer to 2% (the recovery average growth rate).
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The incoming data for July have been a mixed bag, but on balance have cast significant doubt on a strong third quarter performance. The FRBA’s “data-driven” tracking estimate currently puts Q3 growth at 1.9 percent (a.r.), while the MA estimate is a similar 1.8% (a.r.)
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Economists’ expectations for a “snap-back” of real GDP growth to 3% or higher continue to get pushed forward as the economy has failed to deliver consistent growth in excess of 2%. Our statistical models, which project the economy’s most likely course on the basis of the incoming data, have become increasingly pessimistic that the economy will show a significant acceleration from its recent trend.
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The inflation trend appears to have stabilized some recently on a year-over-year basis. But the July retail price data were clearly soft, and provide little evidence of inflation moving back toward the FOMC’s longer-term objective.
FOMC’s longer-term inflation objective
Sources: BLS; Dallas Fed
annualized % change
Overall PCE
Core PCE
Trimmed -mean PCE
August 2013
1.7
1.9
1.6
Past 3 months
2.5
1.7
1.7
Past 6 months
0.6
1.1
1.2
Past 12 months
1.2
1.2
1.3
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This is a very typical “structure” for thinking about, and forecasting, inflation. These are the components that typically go into an economist’s forecast of inflation. The blue “channels” represent commonly held theories of how inflation gets transmitted.
RETAIL PRICES
MATERIAL PRICES
PRODUCER PRICES
LABOR COSTS
MONEY AND CREDIT GROWTH
INFLATION EXPECTATIONS
The Atlanta Fed provides a “dashboard� of these major inflationary forces, scaled by what is statistically typical when inflation has been tracking near its 2 percent longer-term objective.
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There is considerable debate, however, about how much weight (if any) should be attached to the various channels. This “Phillips Curve” channel is particularly contentious. The Phillips curve channel works through cost pressures fueled by excess aggregate demand growth.
RETAIL PRICES
MATERIAL PRICES
PRODUCER PRICES
LABOR COSTS
MONEY AND CREDIT GROWTH
INFLATION EXPECTATIONS
Let me also guess (and I really am guessing here) that an “expectations channel” is getting a lot of the weight in inflation forecasting right now. The expectations channels can work (though not necessarily) directly on prices.
RETAIL PRICES
MATERIAL PRICES
PRODUCER PRICES
LABOR COSTS
MONEY AND CREDIT GROWTH
INFLATION EXPECTATIONS
Most inflation forecasts (like the private-sector forecasts below) tend to show inflation gravitating to the 2 percent longer-term objective over the medium term.
FOMC’s longer-term inflation objective
Actual (core) PCE Inflation
Survey of professional forecasters at various dates
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“Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.� September FOMC statement Barclays 5-year/5-year Forward Breakeven Inflation Rate
Long-Term Inflation Expectations of Consumers
percent
percent, per year, over the next 5 years
4
4
3.5
3.5 Post-recession average: 2.56%
3
3
2.5
2.5
2
2
1.5
1.5 10
11
12
13
data through September 2013
Source: University of Michigan Survey of Consumers
10
11
12
13
data through October 9, 2013 Source: Bloomberg
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While the “most likely� inflation scenario reported by our panel of businesses is 2% in both the short-term and the longer-term, businesses do not judge the risks to inflation as being very balanced. In the near-term, they are weighted to the downside, while over the longer-term, they are decidedly weighted to the upside.
43% 34%
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As of October 2nd, the Federal Reserve’s balance sheet shows total liabilities of $3.8 trillion which reflects an increase of $13 billion from the previous week.
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Since most agree that “inflation is always and everywhere a monetary phenomenon”, does it strike anyone else as curious that we can’t seem to get upward pressure on the inflation measures? y/y % change
y/y % change
Breakdown of the intermediation process can account for much of this.
M2 growth
Base “money” growth
M2 growth
Here is what the inflation forecast based on M2 growth looks like at the onset of the last two QEs (with QE known and assuming historical relationships were to hold.) We should have seen a significant inflation in 2010—in fact, prices disinflated. Likewise, M2 growth earlier last year would have put inflation at over 7%. Do not take these forecasts seriously (I have kind of cooked them up).
12 month percent change
Inflation projection based ONLY on M2 growth
Inflation projection based ONLY on M2 growth
Core PCE inflation FOMC’s longer-term objective
So here’s MY take. Let me emphasize (again) that I do not speak for the FRBA or anyone else who has a vote on policy. 1. Despite clear risks to an acceleration in inflation from a bloated Fed balance sheet—risks that I would ordinarily give great weight given historical experience—the standard money-to-inflation nexus is not playing out as I would have expected. 2. Moreover, the “anchor” of inflation expectations appears to be getting dragged a little. That is, virtually every measure of inflation expectations is holding near its target appropriate level—even as inflation has been consistently tracking under 2 percent. 3. I ordinarily am inclined to be a big believer in the economy is sluggish due to “structural headwinds” story. The problem is, I have a very hard time reconciling that view of the world with the very obvious lack of price and cost pressure. 4. So what would explain the recent consistent undershoot of inflation? Weak demand would. 16
But here (as you probably know) is the official word on this subject: “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.� September FOMC statement
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Thinking about the Outlook for Inflation GIC Central Banking Series Michael F. Bryan Federal Reserve Bank of Atlanta Vice President and Senior Economist
October 10, 2013 These views are mine alone, and do not necessarily reflect the views of the Federal Reserve Bank of Atlanta or the Federal Reserve Board.