Kansas City Fed President Esther L. George has delivered a speech title “Higher Prices: Supply Bottlenecks, Robust Demand, or Both? Lessons from Energy Markets for the Broader Economy”. In this speech, George offers her explanation about recent elevated inflation and draws lessons for monetary policy from energy markets.
Despite the fact that the speech is pretty long and articulated, the headlines have focused almost exclusively on a sentence that sounds very hawkish: “As supply chains heal and demand eases, there is reason to expect inflation will eventually moderate, but it is also clear that the risk of a prolonged period of elevated inflation has increased. The argument for patience in the face of these inflation pressures has diminished”.
The point of this note is to stress that George’s words should be taken as an explanation of tapering, and not as a signal of possible upcoming hikes. Indeed, her speech is much more dovish than implied by the headlines (which is a bit surprising given that George is typically listed on the hawkish camp).
Here are George’s main points
Reasons for currently elevated inflation
- The increase in prices (both in energy markets and in the broader economy) is due to a “combination of resurgent demand and constrained supply”. […] “Fiscal transfers in the United States have supported incomes and spending” […] “Supply disruptions have also contributed to the rise in prices. Notably, shortages of semiconductors have constrained output in a number of industries, including automobiles.” […] “uncertainty remains high for how temporary or persistent these frictions will prove to be”.
- “There are also widespread reports that a lack of available labor is curtailing production in many industries, contributing to kinks in the supply chain and pushing up prices.” […] “It is important to note that the tightness in the labor market could prove temporary as a sizable number of people, about 5 million, remain out of work relative to before the pandemic. […] A full recovery of the labor market appears unlikely until childcare normalizes.”
Lessons for monetary policy from energy markets
- “First, monetary policy should look through temporary increases in inflation.” […] “Given the frequency of temporary shocks to energy and commodity price inflation that are often attributed to supply, core inflation is likely to offer a better measure of underlying or trend inflation and thus is thought to provide an important guide to monetary policy.”
- “Monetary policy should not respond aggressively to increases in inflation resulting from a shift in relative prices” […] “Theory suggests it is better for policymakers to accept this increase in inflation, which should be temporary, than to tighten policy and restrict overall activity in an effort to force offsetting price declines in shrinking sectors.”
Comment. As already mentioned, George’s speech is certainly more dovish than implied by the headlines. Going forward, it seems that even FOMC members traditionally listed on the hawkish side will be patient before hiking, given the uncertainty around the inflation outlook. Monitoring measures of trend inflation should provide a better real-time signal of underlying inflation which in our assessment will continue to be a key factor for monetary policy.