Monetary Policy & Inflation | US
Should the Fed Forget About Inflation Expectations?
- By Sam van de Schootbrugge
- 7 min read
Summary
- A 2021 paper by economist Jeremy Rudd explains why inflation expectations should feature less in the Fed’s reaction function.
- Very little empirical evidence suggests inflation expectations affect current and future inflation forecasts.
- Instead, we should look more towards wage growth to explain inflation dynamics, which could imply a higher terminal rate to stabilise prices.
Introduction
Inflation expectations are arguably the most important input into the Fed’s current and future inflation forecasts. The reason is their self-fulfilling nature – if individuals expect higher inflation, prices will follow suit.
That is why central bankers care so deeply about controlling inflation expectations. In official Fed projections, the difference between anchored inflation expectations and runaway inflation expectations could be catastrophic for interest rates and hence the economy. Indeed, rising near-term inflation expectations are likely a key reason for the Fed’s continued hawkish stance (Chart 1).
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.