Tags: janet yellen | federal reserve | inflation | oil

Yellen's Inflation Lessons: Targets Matter, Oil Shocks Dissipate

Friday, 19 December 2014 09:15 AM

Janet Yellen isn’t likely to change monetary policy because of transitory influences on prices coming from abroad. She’s also not inclined to tolerate a long period of above-target inflation as a way of making up for years of little change in living costs.

Those are among the insights the Fed chair offered investors at her press conference this week.

For Yellen, these issues are now critical. Inflation has been below the Fed’s 2 percent target for 30 months and, with a 45 percent decline in oil prices this year, will remain below it for several more months. Fed officials are wary of inflation remaining too low because it can become a drag on growth.

Yellen illuminated her approach in responses to reporters’ questions. Her views boil down to five points:

1. The inflation goal is 2 percent — and that’s a hard target, not an average over time.

Yellen made clear that she doesn’t view 2½ years of below-target price pressures as a reason to even things out by letting inflation blow past the 2 percent goal.

Here she differs with Chicago Fed President Charles Evans, who told reporters in October that trying to “thread the needle” and land on 2 percent “means that there is some risk that we’re not actually going to get there.”

Yellen said: “It’s important to point out that the committee is not anticipating an overshoot of its 2 percent inflation objective.” Forecasts by members of the Federal Open Market Committee released this week show they will get there in 2016.

2. Market measures of expectations don’t tell the whole story.

One measure — the difference in yields on Treasury debt and inflation-indexed government bonds — suggests investors have lowered their expectations for inflation since September. Today the reading on what the five-year inflation outlook will be in 2019 is 1.96 percent, down from 2.37 percent on Sept. 15.

The decline so alarmed St. Louis Fed President James Bullard that he suggested in an Oct. 16 interview that the Fed should delay the end of its asset-purchase program.

Yellen made clear she doesn’t share that concern, saying that “inflation compensation” — which includes the insurance investors seek to protect the value of their holdings from an unexpected spurt in prices — shouldn’t be confused with inflation expectations.

The reason market measures of longer-run inflation are declining may not only be because expectations are falling, Yellen said. It may also be that the risk of an inflation surprise is falling.

Think of it like auto insurance. Central banks have a good driving record on prices. So investors, like insurance agents, are charging less for risk, and the result is lower yields on Treasuries.

“The jury is out about exactly how to interpret that downward move in inflation compensation,” Yellen said.

3. Yellen takes a textbook view of what causes inflation.

She is watching for the economy to reach a point where tight labor markets lift wages and prices.

“As the labor market recovers, we’ll gradually see upward pressure on both wages and prices,” she said.

Unemployment stood at 5.8 percent in November, just 0.3 percentage point above the level that Fed officials view as full employment.

Next year, when officials expect to raise interest rates, unemployment will be lower and inflation, minus food and energy, may still be as low as 1.6 percent.

Even so, central bankers are “confident in their expectation that inflation will move back toward our 2 percent longer-run inflation objective over time,” she said, as tighter labor market conditions move prices back to the goal.

4. Yellen is willing to overlook temporary price shocks, especially if they are from volatile commodities such as oil, whether they raise or lower inflation.

“As the effects of these oil-price declines and other transitory factors dissipate, and as resource utilization continues to rise, the committee expects inflation to move gradually back toward its objective,” she said.

5. She isn’t worried about imported disinflation.

Year-over-year inflation in the euro area is near zero, and in Sweden it’s negative. In the U.K., inflation is 1 percent, the least since 2002. Goods prices in the U.S. fell 1 percent in November, the biggest decline since 2008, and that’s partially attributable to lower import prices.

Yellen said the decline in oil prices “is one of the most important developments shaping the global outlook,” with a positive net impact for U.S. consumers. Lower energy costs are like “a tax cut that boosts their spending power.”

Headline inflation will finish the final three months of next year in a range of 1 percent to 1.6 percent, the committee’s forecasts show. Minus food and energy, inflation will be in a range of 1.5 percent to 1.8 percent.

Lower oil prices could spill over into core inflation, Yellen said.

“But at this point, although we indicated we’re monitoring inflation developments carefully, we see these developments as transitory,” she said.


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Janet Yellen isn't likely to change monetary policy because of transitory influences on prices coming from abroad.
janet yellen, federal reserve, inflation, oil
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2014-15-19
Friday, 19 December 2014 09:15 AM
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