The Fed Switched Targets from Core PCE to Gasoline?

pa href=https://www.cato.org/people/alan-reynolds hreflang=undAlan Reynolds/a /p pspanThe Federal Reserve used to focus on holding down “core” personal consumption expenditure (PCE) inflation. The median FOMC projection of core PCE inflation at the June meeting was 4.3% for this year, for example. But the last three reports were well embelow/em the FOMC’s expected norm for 2022. Core PCE prices rose at an annual rate of only 3% in February, 3.3% in March and 3.4% in April. /span/p pspanA comparable core PCE figure for May will not be out until June 30. But impatient Fed officials have moved on to new games with new and mysterious rules –such as “find and seek the Quixotic neutral rate.”/span/p pspanMeanwhile, Fed Chairman Jerome Powell has been busily changing the subject and hiding or moving the goal posts. /span/p pspanThe emWall Street Journal/em reports, “While the Fed typically pays greater attention to core prices, which exclude volatile food and energy prices, a href=https://www.wsj.com/articles/powell-says-fed-needs-compelling-evidence-of-inflation-slowdown-to-alter-rate-rise-path-11655904616Mr. Powell has said the central bank must place more focus for now on overall inflation/a [he explicitly mentioned ‘spikes in commodity prices’] because of concerns that consumers and businesses are anticipating price pressures to continue. Fed officials believe expectations of future inflation can be self‐​fulfilling. If those expectations are rising, the Fed could be required to lift rates to levels that push even harder on the monetary brakes.” /span/p pspanRaising central bank interest rates in response to spikes in commodity prices is certainly not a new idea. As I recently emdocumented/em, a href=https://www.cato.org/blog/escalating-oil-prices-fed-funds-rates-preceded-every-recession-1957-2every recession since 1957 was preceded by a dangerous mix of rising oil prices and a rising federal fund rate/a. Few economists believe oil price spikes alone would have sufficed to knock down the agile U.S. economy; the Fed’s assistance was required./span/p pspanAlways ready to help, the Fed Chairman is now redefining what he might be willing to consider as unmistakable evidence of slowing inflation. Such evidence apparently now excludes any good news from Core PCE inflation in favor of “spikes in commodity prices.” Such spikes are, he acknowledges, “beyond our control” yet they somehow justify all interest rates hikes. Why? Because they might affect expectations about future inflation. /span/p pspanSo, there it is. The target seems to have shifted, for the moment, from actual core PCE inflation to estimates of expected future inflation. /span/p p div data-embed-button=image data-entity-embed-display=view_mode:media.blog_post data-entity-type=media data-entity-uuid=0f4e5069-0fbf-4bd8-9892-0c78ea94eac9 data-langcode=en class=embedded-entity img width=1168 height=450 alt=Expected Inflation 5-years Ahead loading=lazy class=lozad d-print-none image-style-pubs-2x component-image data-src=/sites/cato.org/files/styles/pubs_2x/public/2022-06/Cleveland%20Fed%205yr%20expected%20inflation%202004%20to%20May%202022%20-%20under%202.5%25.png?itok=C7YU828_ typeof=Image /div class=d-none d-print-block component-image lozad-print-friendly-image data-background-image=/sites/cato.org/files/styles/pubs_2x/public/2022-06/Cleveland%20Fed%205yr%20expected%20inflation%202004%20to%20May%202022%20-%20under%202.5%25.png?itok=C7YU828_/div /div /ppspanBut why? a href=https://www.cato.org/commentary/does-expected-inflation-explain-or-predict-inflationExpected inflation does not cause of predict/a actual future inflation, nor does it explain past inflation. To see why, look first at the Cleveland Fed’s sophisticated estimate of the inflation estimated five years ahead. Recent 5‑year expectations have not yet reached 2.5% inflation. And the estimates are so obviously cyclical that they have no predictive value at all. If rising oil prices and interest rates create yet another recession as in 2007-09, then expected inflation will indeed fall amazingly fast until the recession is over but no longer. /span/p p div data-embed-button=image data-entity-embed-display=view_mode:media.blog_post data-entity-type=media data-entity-uuid=6fb69c23-01c5-4fbd-ae40-20de337e6b80 data-langcode=en class=embedded-entity img width=1168 height=450 alt=Expected Inflation Depends on Today's Price at the Pump loading=lazy class=lozad d-print-none image-style-pubs-2x component-image data-src=/sites/cato.org/files/styles/pubs_2x/public/2022-06/EXPECTED%20INFLATION%20RISES%20AND%20FALLS%20WITH%20THE%20PRICE%20OF%20GASOLINE.png?itok=oI4NV3TI typeof=Image /div class=d-none d-print-block component-image lozad-print-friendly-image data-background-image=/sites/cato.org/files/styles/pubs_2x/public/2022-06/EXPECTED%20INFLATION%20RISES%20AND%20FALLS%20WITH%20THE%20PRICE%20OF%20GASOLINE.png?itok=oI4NV3TI/div /div /ppspanThe second graph shows the University of Michigan monthly survey of expected inflation one year ahead. How much inflation people expect a year from now depends on what they have recently read in newspaper headlines or experienced at the supermarket or gas station. In fact, as the red line shows, emnext year’s /emexpected inflation clearly rises and falls with emtoday’s/em price of gasoline. /span/p pspanAnother good reason to discard these inflation expectations surveys as a rationale for so‐​called “above neutral” fed funds rate schemes is that linking interest rates to gasoline prices can be highly inflammable. /span/p