Inflation and the Fed

from Economist's View
Mark Thoma

Simon Johnson and James Kwak argue that Ben Bernanke is "radically redefining his institution," and that his "willingness to pump money into the economy risks unleashing the most serious bout of U.S. inflation since the early 1980s, in a nation already battered by rising unemployment and negative growth."

This is, in essence, a question about whether inflation expectations are anchored or not, and that is also the key question is this discussion of the odds of deflation by John Williams of the SF Fed. He argues that the previous decades can be broken into a recent time period in which expectations appear to be well-anchored, the time period 1993 through 2008 is cited in the linked discussion, and a time period in the late 1960s and the 1970s when inflation expectations do not appear to be anchored (based upon Orphanides and Williams 2005). The paper also notes that recent surveys of professional forecasters are consistent with anchored expectations.

But past history shows us that expectations can move from one state to the other, from untethered to tethered, and there's no reason that cannot happen again, but in the other direction. So here I agree with Martin Wolf, it's dependent upon the credibility of policymakers. So long as people believe that the Fed is committed to preventing an outburst of inflation, and that they are capable of carrying through on that commitment, expectations will remain well-anchored. But if people believe that that Fed's hands are tied because of the harm reducing inflation would bring to the real economy, an out of control deficit, or due to political considerations that force them to accept inflation they could and would battle otherwise, then we have a different situation and long-run inflation expectations will change accordingly.

(Continued here.)