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Williams Worried About Too-Low Inflation

As noted in the Wall Street Journal, N.Y. Fed’s John Williams Calls for Reassessing Inflation-Targeting Framework.

Also consider Fed Should Be Vigilant About Too-Low Inflation

  1. The Federal Reserve needs to make sure that tight labor markets do not spark a sustained surge in inflation, but equally that inflation expectations do not get stuck too low, New York Federal Reserve Bank President John Williams said.
  2. "I concur that we must remain vigilant regarding a sustained takeoff in inflation," New York Federal Reserve Bank President John Williams said.
  3. Inflation's recent track record of riding well below the Fed's 2-percent target is, therefore, concerning, he said.

Phillips Curve Nonsense Yet Again

In case you missed it, point number one is the many times discredited Phillips Curve.

A New York Fed speech out today by John Williams asks Is the Phillips Curve Dead or Is It Just Hibernating?

The apparent breakdown in this simple price Phillips curve in the past 30 years reflects a number of structural changes in the U.S. economy. The Federal Reserve’s success in re-anchoring inflation expectations at a low level can explain the decline in inflation persistence seen in the data. However, the role of well-anchored expectations in flattening the Phillips curve is not obvious, and as HMS note, this flattening is not as clear in the wage inflation equations. This suggests other forces are at work.

We must be equally vigilant that inflation expectations do not get anchored at too low a level. So far during this expansion, core and overall PCE inflation has averaged about 1.5 percent, well below the Fed’s 2 percent target. Taking a longer perspective, over the past 25 years, core and overall inflation have both averaged 1.8 percent.

This persistent undershoot of the Fed’s target risks undermining the 2 percent inflation anchor. In this regard, research by Ulrike Malmendier and Stefan Nagel is sobering. They find that inflation expectations are heavily influenced by the inflation experience in one’s own lifetime, which implies that decades of too low inflation can become embedded in expectations. Indeed, we have seen some worrying signs of a deterioration of measures of longer-run inflation expectations in recent years.

Inflation Expectations

Got that? The Phillips curve has not worked for 30 years because the Fed was successful anchoring inflation expectations at a low level "in one's own lifetime" as if anyone was ever concerned about inflation in any other lifetime.

Nonetheless, Williams concludes "In summary, the Phillips curve is alive and well. I wholeheartedly agree with the authors that we must not be complacent about inflation expectations becoming unmoored, whether at too high or too low a level."

In Search of the Phillips Curve

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Phillips Curve Not Alive and Well

Wikipedia offers this amusing comment: "In recent years the slope of the Phillips curve appears to have declined and there has been significant questioning of the usefulness of the Phillips curve in predicting inflation. Nonetheless, the Phillips curve remains the primary framework for understanding and forecasting inflation used in central banks." ​

Believers Hold Firm

In March of 2017, then Fed Chair Janet Yellen commented in a post-FOMC Q&A “The Phillips Curve is Alive“.

Stanley Fischer, then Vice-Chair also mentioned falling unemployment as a determinant for rising inflation.

The Phillips Curve is not alive and well. It was never alive to begin with. Yet, Fed groupthink economists still insists the Phillips Curve works.

Inflation Expectations Well Anchored

Similarly, inflation expectation groupthink is in play.

It's safe to say that all the Fed presidents believe in inflation expectations. If they don't, they do not become Fed presidents.

Moreover, they all believe inflation expectations are "well-anchored", and In the case of John Williams, "too well-anchored".

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The idea behind inflation expectations is that if consumers think prices will go down, they will hold off purchases and the economy will collapse. The corollary is that is consumers think inflation will rise, they will rush out and buy things causing the economy to overheat.

Let's test the theory out with a set of practical question regarding the CPI and spending habits.

CPI Percentage Weights

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Inflation Expectations Rebuttal

I blasted the inflation expectations theories in my post Stupidity Well Anchored: Absurdity of Inflation Expectations in Graphic Form.

Inflation Expectations Q&A

Q: If consumers think the price of food will drop, will they stop eating out?
Q: If consumers think the price of food will drop, will they stop eating at home?
Q: If consumers think the price of natural gas will drop, will they stop heating their homes and stop cooking to wait for the event.
Q: If consumers think the price of gas will drop, will they stop driving or not fill up their car if it is running on empty?
Q: If consumers think the price of gas will rise, can they do anything about it other than fill up their tank more frequently?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens?
Q: If consumers think the price of rent will rise, will they rent two apartments to take advantage?
Q: If consumers think the price of plane tickets, taxis, and bus tickets will drop, will they hold off taking the plane the train or the bus?
Q: If consumers think the price of plane tickets, taxis, and bus tickets will rise, will they rush out and buy multiple tickets driving the prices even higher up?
Q: If people need an operation, will they hold off if they think prices might drop next month?
Q: If people need an operation, will they have two operations if they expect the price will go up?

Inelastic Items

All of the above questions represent inelastic items.

Those constitute 80.254% of the CPI. Commodities other than food and energy constitute the remaining 19.746% of the CPI. Let’s hone in on that portion with additional Q&A.

Q. If someone needs a refrigerator, toaster, stove or a toilet because it broke, will they wait two months if for some reason they think prices will decline?
Q. If someone does not need a refrigerator, toaster, stove or a toilet will they buy one anyway if they think prices will jump?
Q. The prices of TVs and electronics drop consistently. Better deals are always around the corner. Does that stop people from buying TVs and electronics?
Q. If people thought the price of TVs was about to jump, would they buy multiple TVs to take advantage?

For sure, some people will wait for year-end clearances to buy cars, but most don’t. And if a car breaks down, consumers will fix it immediately, they will not wait for specials.

Stupidity Well-Anchored

The only thing that’s “well-anchored” is the stupidity of the belief that inflation expectations matter.

Asset Irony

People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices will go down.

People will buy houses to rent or fix up if they think home prices will rise. They will hold off housing speculation if they expect prices will drop.

The very things where expectations do matter are the very things the Fed and mainstream media ignore.

BIS Deflation Study

The BIS did a historical study and found routine deflation was not any problem at all.

**“***Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive*,” stated the study.

Thus, Williams' concern about "too-low" inflation is seriously misguided.

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Mike "Mish" Shedlock