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Mercy Me! Inflation Expectations Are No Longer Well Anchored

Hello Fed. Let's discuss "well anchored" inflation expectations.
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Inflation Expectations vs Year-Over-Year Inflation Measures 2021-06

The New York Fed's latest Survey of Consumer Expectations shows another huge leap in inflation expectations.

The June 2021 Survey of Consumer Expectations shows that median inflation expectations at the short-term horizon climbed 0.8 percentage point to 4.8 percent, while inflation expectations at the medium-term horizon remained unchanged. 

Inflation Data Description

  • Median one-year ahead expected inflation rate: Respondents are asked for the percent chance that, over the next 12 months, the rate of inflation (deflation) will be 12% or higher; between 8% and 12%; between 4% and 8%; between 2% and 4%; between 0 and 2%. A generalized beta distribution is fitted to the responses of each survey participant and the mean of this distribution is calculated. This is the respondent’s “expected inflation rate”.
  • Median point prediction: Respondents are asked what they think the rate of inflation will be over the next 12 months. This is a point prediction (a single-value forecast).
  • The three-year forecasts are for three years instead of one.

Parroting the News?

One has to wonder how much of this is real opinion vs constant news recently of higher prices.

I suspect a bit of both as prices have gone up, but either way it's irrelevant, because:

Inflation Expectations Are Meaningless

Contrary to widespread belief that inflation expectations matter, they are actually meaningless and the above charts show just that.

For most of eight years reported inflation was under 2% and often under 1%, and briefly negative. Yet, the look ahead median point prediction was never below 2.9%.

If expectations mattered, why did the CPI and PCE stay below 2% so long? 

A look at CPI components shows how silly it is to believe in inflation expectations.

CPI Percentage Weights

CPI Percentage Weights Elastic and Inelastic

I highlighted inelastic items.

Perhaps a portion of education is elastic. But a portion of other housing is inelastic as is a portion of communication and other goods.

Recreation is elastic and so is apparel (assuming one does not ruin one's only coat or shoes).

Somewhere between 80% and 90% of household purchases are inelastic.

Inelastic Item Questions

Q: If consumers think the price of food will drop, will they stop eating? Will they eat twice as much if they expect prices will rise?

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Q: If consumers think the price of gas will drop, will they stop driving?

Q: If consumers think the price of rent will drop, will they hold off renting until that happens? Will they rent two apartments if they expect the price to rise?

Q: Will consumers delay medical services if they think prices will drop? Will they have two operations if they think prices will rise?​

Elastic Item Questions

Q. Better deals on TVs and computers are always around the corner. Does that stop TV and computer purchases?

Q. If someone wants a new refrigerator, toaster, or stove will they wait two months if they think prices will decline?

Asset prices are a different matter, however.

Asset Price Expectations

  • People do buy stocks it they believe prices will rise. They avoid stocks or sell them if they expect prices will drop.
  • People will stretch to buy a home if they expect prices to rise. They wait if they expect prices will drop.

Note that every member of the Fed talks about expectations that don't matter ignoring those that do matter.

And not only does the Fed ignore asset price expectations, they ignore asset prices totally. That's how you get three enormous bubbles in 20 years.

Inflation Expectations vs Year-Over-Year Inflation Measures Since 2013

Inflation Expectations vs Year-Over-Year Inflation Measures 2021-06A

Expectations Fantasy

  • For most of 8 consecutive years, year-over-year CPI and PCE was under 2%.  
  • In that same time frame, the Median 3-year estimate and the median point projections was seldom below 3%.
  • If inflation expectations mattered, that chart would be impossible.
  • Alternatively, one might say people believe low inflation is transitory.
  • Yet, we constantly hear the Fed yapping "Inflation expectations are well anchored".

It's a good thing for the Fed that expectations don't matter because 5+% expectations can no longer be considered well anchored. 

The only thing that's clearly well anchored is Fed groupthink silliness. 

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