The Fed’s New, Squishy Inflation Target

In reading over the monetary policy changes the Federal Reserve announced yesterday (as detailed here) and noting how they intend to tie interest rate decisions (and perhaps other policy changes) to both the jobless rate and the inflation rate, it occurred to me that their inflation target has lots of wiggle room in it.

For better or worse, it’s pretty clear what unemployment rate they’ll use as the Labor Department publishes this every month and, though it has its share of quirks (e.g., the official jobless rate went down last month as the number of employed people fell), when the Fed says they’ll keep monetary policy super-easy until the unemployment rate falls below 6.5 percent, at least everyone knows what that means.

But, their new inflation target is a different, squishy thing that, per the policy statement, has two components - their own future projections for consumer prices and the meaning of the phrase “well anchored”. It’s highlighted below, right from the policy statement:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Admittedly, no one is really concerned about inflation these days, so, for a little while a least, I don’t think anyone’s going to be asking too many questions about this, but, clearly, people are already confused and, someday, it really might matter.

It’s pretty common to find statements like this that in no way reflect what the Fed said yesterday:

They’ve said that interest rates will remain low until unemployment falls below 6.5 percent or the inflation rate exceeds 2.5 percent…

Here’s another example:

…the Fed said that it plans to continue to keep interest rates low until unemployment drops to 6.5 percent, or until inflation hits 2.5 percent.

Their new inflation target is not nearly as simple as what many people seem to think and breaking it down into its constituent parts might shed some light on exactly how squishy it really is.

The first component - inflation projections - are apparently the Fed’s own forecasts. They didn’t say so, presumably, because it would have been much less convincing to say “inflation, based on our own projections, of no more than 2.5 percent…” rather than the more circuitous route taken in the policy statement above.

Nonetheless, for those who have scrutinized the statement closely, that appears to be the consensus and it just so happens that they released a new forecast just yesterday:

Naturally, Federal Reserve economists forecast inflation of just under two percent.

That’s their target, so, why would any Fed economist think the result might be any different when looking out over the next year or two. Despite their recent failings, they remain a confident bunch and to predict inflation of, say, 3 percent or 4 percent that far out would be tantamount to saying, “We’re going to fail at our job”.

If more people were concerned about inflation today, then there would surely be more discussion about this particular “target”, but they’re not, so there isn’t.

I just don’t see how, even if current inflation is running at 5 or 10 percent, the Fed will do anything other than predict inflation at two percent two years hence - maybe 2.5 percent - so, this really isn’t a target at all.

As for the second component of the new inflation target, that is, that “longer-term inflation expectations continue to be well anchored”, this too is pretty squishy.

Of course there are the yield spreads between Treasuries and inflation protected Treasuries, but, for the foreseeable future, the Fed will be one of (if not the) biggest buyer of U.S. debt and this tends to keep Treasury prices high and yields low. Whatever value there used to be in yield spreads as they relate to inflation, it’s not what it used to be since the Fed has a rather large presence in this particular market.

Consumer confidence surveys are also used as gauges of inflation expectations and it’s worth noting that last week’s consumer sentiment survey from the University of Michigan had the five-year inflation outlook up one-tenth to 2.9 percent.

The latest consumer confidence survey from the Conference Board had inflation expectations edging lower, down from 5.8 percent to 5.6 percent, so, it’s a pretty safe bet that they won’t be using either one of these to determine if inflation expectations are “well anchored”.

All in all, the Fed’s new inflation target is much less than meets the eye and this could have important implications for investors someday. 

There will be lots of “wiggle room” for the Fed if and when the time comes that consumer prices do begin a sustained rise and this would favor the natural resource sector in general, monetary metals in particular. With the Fed now promising to print $1 trillion in new money each year until such time that the economy improves, the odds of inflation someday mattering again have gone up substantially, albeit from very low levels.

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6 Responses to The Fed’s New, Squishy Inflation Target

  1. Steve White December 13, 2012 at 5:00 PM #

    I read this statement as simply saying that the Fed will keep rates low until the economy recovers or they come up with a better plan. The economy is not likely to recover and BB is out of new ideas because there aren’t any.

    Looking back over the statements BB has made about how long he would keep rates low, at first, there was a firm deadline. Then, the deadline was extended a couple of times and now we’re hearing, just a few short months after the last extension, that ZIRP will continue until the Fed decides to raise rates based on its own assessments of inflation (how comforting!) and the unemployment rate. So much for the Date Certain approach he was using. Same song and dance for QE.

    Not only is CPI data routinely and easily manipulated, the employment data is easily manipulated, as we’ve seen recently. So, BB’s statement means nothing.

    I don’t how many different ways he can telegraph this without coming right out and admitting it: ZIRP is here to stay unless a miracle occurs (super strong growth in the economy) or a disaster occurs (currency crisis). He’s praying for the former and I’m betting on the latter. But it will take a LONG time to occur…

    There is no end in sight for ZIRP and our economy is not going to turn around. I know this because I know that high rates will kill our debt-laden economy (and the world economies). I also know that we are now in a globalized world market where we compete with all the low labor cost countries. We were one of the highest paid laborers in the world and now, because of globalization, we have to accept that those halcyon days of yore are over.

    Short of a miracle (and I do mean something miraculous like free energy or perpetual motion), America is in a long, slow, steady decline toward a worldwide average standard of living. Other countries such as the Far East, South America and many other areas are in a long slow, steady increase in standard of living. We meet in the middle and the middle is a long way down for us Americans.

    Until ETs from another world get into the market, globalization tells you what you need to know about America’s future economic health and it’s not pretty. Since we’re now hooked on ZIRP and QE, there’s nowhere else to go with economic policy. Even if rates go NEGATIVE, it will just come from printed money.

    ZIRP/QE are like meth: Once you start, there’s no easy way to kick it.

    Commodities (real things) will do well as people get more and more concerned. Anyone who can make a buck on the spread offered by super low rates will be rewarded. Savers are screwed.

    • Tim December 13, 2012 at 5:31 PM #

      “We meet in the middle and the middle is a long way down for us Americans.”

      How true…

  2. DCX2 December 14, 2012 at 4:30 PM #

    I know your focus was the squishy inflation target, and it seems like you believe inflation will hit first before unemployment gets lower. This is my belief, and let me tell you why.

    We are a nation of too many people and we do not have enough valuable work - work that is valuable enough that society will pay a living wage for it to be done - for all these people to do. The work can either be done more cheaply with machines (given upfront capital investment), or by offshoring the work to locales with lower wages. However, society has determined that we will use employment as a proxy for what standard of living is deserved.

    Probably half, and maybe more, of the nation would soundly reject the idea of “mincome”, deriding the whole idea as a bunch of freeloading. We are, as a nation, unprepared to pay people in excess of the value of the work they do, just to keep them employed and living. Certainly we could pay people to do things like clean up the sides of roads, and that is valuable, but we can’t pay everyone enough to live off of work like that. We are similarly unprepared to train our population en-masse to do new valuable work, because such training would take require upfront capital investment in the form of “free” education funded by taxpayers.

    So I have a serious question for everyone who reads this. What are we going to do with the people who simply cannot find employment that generates sufficient income to live above the poverty line, no matter how badly these people search for such employment?

    • Steve White December 15, 2012 at 4:18 PM #

      This will not be received well… But, you need to hear the truth…

      In reply to the question of what we should do with people who can’t find decent paying work, I submit the answer is that some problems simply cannot be fixed. Not every problem has a solution and the idea that the magical government can fix all problems is just another version of believing in Santa Claus.

      Stuff happens. All around. Good things happen to bad people and vice versa all the time. We are not born into this world with a guarantee that we will never suffer in any way, no matter what all the politicians tell you.

      The more local the solution, the better. The bigger the solution, the less likely it will work. I will take care of myself and my family first. If I have any excess, I will give to my church and help my neighbors. You do the same and that’s all you can do.

      If everyone did that, then that’s all we can do as a community, city, state, nation, etc. One of the many problems with government is that people begin to think there will always be someone else to take care of problems and they can just ignore them because that’s what they pay taxes for. So, they don’t do anything local at all; always waiting for someone else to “fix it.”

      You’ll never know what will happen to people such as those you are worried about so much until you get out of the way and let nature take its course. Some of them will surprise you to the upside and many will not.

      It’s not what anyone wants to hear because it isn’t a bedtime story with a happy ending and it sounds cold, harsh and mean-spirited. But it really isn’t. Truth hurts and reality is a bitch sometimes. We simply have no idea how much harm we’ve already caused in this world by acting as if government is the answer to everything. Running the country into the deepest debt pit the world has ever seen is not kind to the generations yet to come. But, they are not here whining about it, so we can ignore them.

      Training the masses to do valuable work is a pipe dream. The internet provides so many ways to get an “education” today that have never been available before, it’s simply amazing to me. Those who want to learn will find a way but, the sad fact is that most people simply won’t do it whether it’s free or not.

      Like I said up front, you won’t like this answer because it’s not the happy ending you’ve grown accustomed to hearing.

    • AceChase December 16, 2012 at 5:07 PM #

      Well, I think that if we look carefully at the underground market that is now occurring for low wage people, you can find the types of work that the less-skilled would consider. For instance, gardeners, maids, paid “elderly help,” etc. Making this type of work legal and simple would solve a lot of problems. Perhaps allowing each person to employ one other (during a specified period) paying (at least) the Federal minimum wage, and for (at maximum) the Federal daily hours allowed. In this case, although records would be required to be kept, there would be no other action required. i.e., no tax of any kind due from either party to the agreement, no forms to be filed, etc. This would essentially legalize what is happening anyway, and provide many, many low wage jobs for the lower-skilled among us.


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