The Fed: Deer in Inflation’s Headlights

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The word “inflation” appears 73 times in the Minutes of the latest FOMC meeting, held from January 25-26. The Minutes suggest that most participants believe that “[s]upply and demand imbalances related to the pandemic and the reopening of the economy had continued to contribute to elevated levels of inflation.” In other words, they blame inflation on the pandemic and refuse to even consider the possibility that excessively stimulative fiscal and monetary policies triggered the demand shock that caused the supply shock.

That explains why most Fed officials continue to favor a very gradual withdrawal of monetary accommodation rather than an abrupt tightening of monetary policy. While they no longer characterize inflation as “transitory,” they remain optimistic that inflation will abate in coming months: “Progress on vaccinations and an easing of supply constraints were expected to support continued gains in economic activity and employment as well as a reduction in inflation.” It all depends mostly on “the course of the virus.” Here’s more on the committee’s discussion about inflation:

(1) Cost-push inflation and a wage-price spiral. The Minutes acknowledged that there are mounting signs of cost-push inflation and a wage-price spiral: “Nevertheless, several participants reported that their contacts expected the ongoing labor shortages and other supply constraints to persist well after the acute effects of the Omicron wave had waned. Participants’ contacts also reported continued widespread input cost pressures, which, amid generally robust demand, they reported having largely been able to pass on to their customers.”

(2) Persistent inflation. Some participants suggested that inflationary pressures might persist even if the pandemic continues to abate: “However, some participants commented that elevated inflation had broadened beyond sectors most directly affected by those [pandemic-related] factors, bolstered in part by strong consumer demand. In addition, various participants cited other developments that had the potential to place additional upward pressure on inflation, including real wage growth in excess of productivity growth and increases in prices for housing services.”

(3) ‘Transitory,’ the unspoken word. On November 30 last year, Fed Chair Jerome Powell told Senate lawmakers, “I think it’s probably a good time to retire that word [‘transitory’] and try to explain more clearly what we mean.” Indeed, the word doesn’t appear in the latest Minutes; yet the notion of transitory inflation still governs committee members’ thinking, as suggested by the following statement: “Participants generally expected inflation to moderate over the course of the year as supply and demand imbalances ease and monetary policy accommodation is removed.”

(4) Anchors away. “Delusional” is the only word I have to describe the following statement in the Minutes: “Some participants remarked that longer-term measures of inflation expectations appeared to remain well anchored, which would support a return of inflation over time to levels consistent with the Committee’s goals.”

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