Economics

The Truth Behind Today’s US Inflation Numbers

Jun 2, 2017 J. Bradford DeLong

When the US Federal Reserve began to raise interest rates in December 2015, it issued a median forecast that, in retrospect, significantly overstated the strength of the US economy. This suggests that the Fed's monetary policies, in combination with fiscal policies, are not doing enough to stimulate the US economy.

BERKELEY – In December 2015, the US Federal Reserve embarked on a monetary-tightening cycle, by raising the target range for the short-term nominal federal funds rate by 25 basis points (one-quarter of a percentage point). At the time, the Federal Open Market Committee (FOMC) – the Fed body that sets monetary policy – issued a median forecast predicting three things.

First, the FOMC indicated that the December 2015 rate increase would be the first of five such increases that it would make within the subsequent year, and the first of nine that would take place by, say, September 2017. Second, the federal funds rate would reach 2.25-2.5% within three months of the December 2015 increase. And, third, the Fed’s preferred measure of inflationary pressure – the core personal consumption expenditures (PCE) price index – would be at 1.9% per year by now.

All told, the FOMC’s forecast has not been borne out. If the Fed actually does increase interest rates this month, it will have undertaken only four of the nine anticipated rate hikes. Moreover, it believed that nine rate hikes before the end of this summer would be necessary to keep inflation below its target of 2% per year. But inflation is expected to rise at an annual rate of just 1.5% for the rest of this year, and next year.

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J. Bradford DeLong

Writing for PS since 2002
252 Commentaries

J. Bradford DeLong, Professor of Economics at the University of California, Berkeley, is a research associate at the National Bureau of Economic Research and the author of Slouching Towards Utopia: An Economic History of the Twentieth Century (Basic Books, 2022). He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

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0 Comments on this paragraph, 14 Comments on this article

G. A. Pakela Jun 7, 2017

It took a multi-decade effort, with tightening episodes implemented within the business cycle in order to tame inflation and remove it as a source of uncertainty. It is clear that the Fed has no power to precisely match its policies to a GDP or inflation target within a short and predictable time frame. Today's inflation rate is a function of the inflationary psychology having been eliminated.
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Thaomas H Jun 6, 2017

And as for "Secular Stagnation," this seems like a particularly unfortunate for what in Summers's own analysis is the unwillingness of the Fed to fulfill its mandate to maintain a predictable increase in the price level over time.
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Thaomas H Jun 6, 2017

It seems clear that the Fed has treated and is treating 2% inflation as a ceiling rather than a a target. This seems clearly at odds with the "stable prices" half of its mandate. "Stable prices" ought to mean that economic actors can form reasonable expectations about future price levels based on knowledge that if the price level at any given time is above or below the target for its trend level the Fed will take action to raise or lower inflation -- buy or sell some asset -- to bring the level back toward the target. Since the Fed is not behaving in a predictable way, the resulting unnecessary uncertainty about future price levels must be a drag on real economic growth.

Why might the Fed be behaving in this way to impede real growth? Two hypotheses come to mind. 1) Actions to increase inflation in ways necessary to bring a below-target price level back toward target would, at a particular conjuncture, require the Fed to purchase "unconventional" assets and the Fed feels politically constrained to do this. 2) The Fed fears that the purchase of assets needed to bring the price level down toward target would require, in some conjuncture, raising interest short term interest rates "too rapidly" in ways unexpected by banks and the Fed feels politically constrained to do this (and therefore self imposes an inflation rate ceiling so as never to have to raise rates in this way ). Monetary theorists ought to be examining the (un) optimality of an inflation ceiling and Fed commentators ought to be investigating the incentive structure that is leading the Fed to behave in un-optimally.
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george jonisch Jun 5, 2017

This is one of many articles that evokes confusion in this non-economist. As I experience the economy I am struck by the price rise in the following items. College tuition, cars of similar quality over time, food that I actually eat at home. Food that I eat in restaurants. Price of homes. Price of apartment rentals. Price of Internet related services. Price of top of the line computers. The only price I have experienced that has gone down is that of oil and its offshoots.
Is it possible that statistics used are misleading and therefore account or cause these contradictory views, conclusions, and policies?
Can someone clarify?
- dw b Jun 5, 2017
  
  Local inflation can be different than average USA inflation. Local unemployment can also be much higher than the USA average (in some cities it's double the national average). You did not say where you live.
  
  The cost of living is much higher in urban areas and can often be attributed to local economic phenomena, like scarce real estate and high labor costs. Paradoxically, unemployment is also often higher in urban areas and labor force participation lower.
  
  As far as "cars of similar quality over time" this is difficult to gauge - I just bought my first car in 9 years. It was about the same price as the same model 9 years ago, but it had a much better transmission, better gas mileage, rear view camera, better speaker and smartphone interface, and a built-in nanny that tells me when cars are in my blind-spot (and prevents me from searching for directions when the car is moving) - and too many other features to mention.
  
  The "Price of top of the line computers" might not be going down, but top line computers and top gaming systems are more like status symbol goods, so demand is proportional to price.
  
  In short, inflation and unemployment is a kind of average and no one in the USa is really average.
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Allan Glanzman Jun 4, 2017

this discussion ignores the relative risk of over vs. undershoot perhaps the economic cost of over and under estimating is not equal in impact when you make a mistake, History tells us runaway inflation is significantly more dangerous then tepid growth, and harder to control/fix.
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dw b Jun 3, 2017

You cannot logically distinguish the "secular stagnation" hypothesis from "the Fed has now overestimated the strength of the US economy for 11 consecutive years."

The Fed overestimating the strength of the economy leads to too-tight policy, and thus an economy that looks like one growing too slow.

The Fed will lose it's independence, probably in favor of pure rules-based policy, and will only have itself to blame. The FOMC is probably a zombie institution - already dead it just does not know it yet.
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Richard Graham Jun 3, 2017

This paragraph underlines thee fact that economics is junk science at best.
And self-serving conservative lies the rest of the time.
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Richard Graham Jun 3, 2017

This paragraph underlines the fact that economics is junk science at best.
And self-serving conservative lies the rest of the time.
A new reply to this comment has been posted.
Paul Daley Jun 2, 2017

The FED's problems do not lie in its Forecasting and policy-making. Its problems are operational. The tools it uses to intervene in asset markets impact goods and services prices only weakly. That is the problem.

The FED needs to develop a second channel for operations that will allow it to lend against earned income and more directly impact demand for goods and services. I've suggested that the FED use the IRS withholding system as a channel for lending, but there are lots of ways to channel funds more directly to markets for goods and services. That is what's needed.
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James Conner Jun 2, 2017

Or maybe 9yrs of below O real rates and QE fueled demand for for fixed income has allowed funding to reach businesses that would not have normally been funded at these low rates. Thus increasing capacity in every industry on the planet. The resulting price competition has caused a massive deflationary headwind.

This extremely easy money has also caused a ramp up in the items the middle class spends most of their money on, housing, education and healthcare. With the absence of real wage growth, there has not been much money leftover to drive the economy. A thriving middle class is what we need to drive real economic growth. The Central Banks of the world have engineered the exact opposite. Time to put a spike in trickle down economics and change course.
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Steve Hurst Jun 2, 2017

It is obvious there is no vee notch recovery as in the days of old text books. Following the Gt Recession the US economy took best part of a decade to crawl back to baseline on the back of US public debt doubling in nominal terms. All we are seeing is more of the same trough. In other words the Gt Recession was a financial nuclear weapon of mass destruction utilsing the very best technology on a truly massive scale. When are economists really going to look at the facts instead of talking about an obsolete model for guidance. There was a choice in the Gt Recession, the collapse and clear out of failed private corporations, or indulge in massive debt to prop them up. The choice was the latter and a trough is the outcome because we are still living with the fallout and an nuclear extended half life.

God help the West when interest rates do go up because if it is not accompanied by real wages rising the debt problem will incapacitate, and God help the West if interest rates coupled with inflation dont go up because inflation is the only way to get rid of the debt. A continued half life is the most likely outcome, and a deliberate one at that
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