The Asininity of Inflation Expectations, Once Again By Powell and the Fed – Mish Talk

June 27, 2022

Inflation Expectations and Treasury Yield

What Do Financial Markets Say about Future Inflation?

From the Federal Reserve Bank of St. Louis, please consider What Do Financial Markets Say about Future Inflation? by YiLi Chien and Julie Bennett.

The Importance of Inflation Expectation

The effectiveness of monetary policy hinges critically on inflation expectations. If economic agents, such as households and firms, expect higher inflation in the future, the rational reaction is to purchase goods and services right away in order to avoid higher future prices. As a result, the demand for goods and services immediately rises and so does the price level, which results in higher inflation right away. Hence, the Federal Reserve needs to anchor economic agents’ long-term inflation expectations close to the inflation target in order to effectively combat inflation. This blog post looks at the recent movements in so-called market-based inflation expectations for various time horizons.

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Conclusion

In short, according to the inflation swap data, market participants believe the Federal Reserve can and will control the high inflation rate, despite price increases being more persistent than previously thought. The well-anchored longer-term inflation expectation provides additional supporting evidence of this.

I will rebut this nonsense again, but first let’s consider another article on the alleged importance of inflation expectations.

The Strange Art of Asking People How Much Inflation They Expect

Please consider The Strange Art of Asking People How Much Inflation They Expect

“By about what percent do you expect prices to go up or down on the average, during the next 12 months?”

The answers people give to this question—this exact question—produce one of the most important numbers for the U.S. economy.

It’s the question the University of Michigan asks respondents to its Survey of Consumers. Because that survey is the longest-running such survey of consumer attitudes, dating back to 1946, its data about price increases have become the benchmark for economists who obsess over expectations of inflation.

When Federal Reserve Chairman Jerome Powell said last week that the Fed was raising interest rates by 0.75 percentage point, he cited an uptick in the responses people gave to the Michigan survey, saying, “It was quite eye-catching and we noticed that.”

Crucial Variable Says Gregory Mankiw

“Expected inflation is a crucial variable, but it’s probably one of the hardest of the crucial variables to measure,” said Harvard University economist Gregory Mankiw.

The first quirk is that many people have only a vague idea of how much prices will rise, and tend to respond with large (sometimes implausibly large) round numbers: 5%, 10%, 15%, even 50%. In other words, people don’t gravitate toward a common assessment—they disagree sharply about how much inflation to expect, as Mr. Mankiw puts it.

Second, partisanship colors people’s views. This is a well-known trend when assessing measures of consumer confidence: Democrats become extremely optimistic, and Republicans extremely pessimistic, the moment a Democratic president is elected. And vice versa. It has recently come to hang over inflation data, too.

The question “by about what percent per year do you expect prices to go (up/down) on the average, during the next 5 to 10 years?” is followed by a careful script to ensure that people are providing an estimate of annual increases, not cumulative.