Fed Governors C. Waller and R. Quarles delivered two important speeches in the last few days. Both speeches contained relevant information about how each Governor sees recent inflation dynamics and outlines possible monetary actions.
We report the relevant messages from each speech. To summarize: Quarles seems to be fully on board with the Fed staff view, while Waller appears definetely more hawkish and does not seem to pay much attention to exclusion measures as a guide for future inflation.
Starting with Governors Waller, he continues to believe that the current elevated inflation will prove transitory. However, Waller stressed the upside risks to the forecast and the fact that bottlenecks have been worse than anticipated. Not only but Waller offered a critical interpretation of the Trimmed means in order to caution against putting too much faith in them. (personal comment: honestly, I think his analysis of the Trimmed mean is not correct – we can talk about this over the phone or at our next meeting). As for policy actions, Waller said that he does not see liftoff to occur soon after tapering is completed, unless high inflation will persist well into 2022.
Switching to Governor Quarles, he also acknowledged that supply constraints in production and distribution have become more widespread and have lasted longer than anticipated. However, while he thinks that “transitory” does not mean “short-lived”, he also thinks that the FOMC is not behind the curve for three reasons: most of the biggest drivers of the very high current inflation rates will ease in coming quarters, some measures of underlying inflation pressures are less worrisome, and longer-term inflation expectations are anchored, at least for now. Not only but he cautioned that because of the lagged effects of monetary policy on economic activity, an aggressive move now might result in a pro-cyclical effect. As for policy actions, Quarles supports tapering at the November meeting but he reaffirmed that the bar for lift-off will much higher.
Comment: in our latest “FOMC meter”, we had Quarles as “Neutral” and Waller as “Hawkish”. Therefore, the tone of their speeches is not a surprise (if anything, Waller sounded a touch more hawkish than usual, while Quarles a touch more “dovish”). The only possible news is that FOMC participants are now admitting that supply bottlenecks are taking longer to solve than expected and that inflation is a bit more broad-based than previously assumed. As usual, it will be crucial monitoring the incoming data to assess whether the inflationary pressures are becoming less concentrated than they currently are.
Fed Waller (“The Economic Outlook and a Cautionary Tale on “Idiosyncratic” Price Changes and Inflation”)
https://www.federalreserve.gov/newsevents/speech/waller20211019a.htm
- “I continue to believe that the escalation of inflation will be transitory and that inflation will move back toward our 2 percent target next year. That said, I am still greatly concerned about the upside risk that elevated inflation will not prove temporary.”
- “I still see supply and demand working here to moderate price increases so that inflation moves back toward 2 percent. But I also see some upside pressures on inflation that bear watching. Bottlenecks have been worse and are lasting longer than I and most forecasters expected, and an important question that no one knows the answer to is how long these supply problems will persist.”
- “I would like to follow up on this last point as it pertains to thinking about inflation. As I mentioned earlier, a lot of commentators, including me, have deflected concerns about high inflation readings being the result of “outliers” or “idiosyncratic” price movements.” […] “These measures censor the tails of the price change distribution to avoid having average inflation distorted by extreme price movements. However, inflation is distilled from many prices, and those prices do not move uniformly. As a result, we may be led to “falsely” dismiss certain price movements and risk being misled as to the true inflation rate.”
- “A critical aspect of our new framework is to allow inflation to run above our 2 percent target (so that it averages 2 percent), but we should do this only if inflation expectations are consistent with our 2 percent target. If inflation expectations become unanchored, the credibility of our inflation target is at risk, and we likely would need to take action to re-anchor expectations at our 2 percent target.”
- “I also look at the Board of Governors staff’s common inflation expectations measure, which distills a signal from both surveys and market-based inflation gauges. At this point, at least, it remains near its average over the past decade. This gives me some comfort that the recent run of high inflation readings has not led to an unanchoring of inflation expectations. It is important to account for all measures of inflation expectations and not “cherry pick” the measure that one finds most comforting.”
- “Based on my outlook for the economy, however, I do not expect liftoff to occur soon after tapering is completed. The two policy actions are distinct. I believe the pace of continued improvement in the labor market will be gradual, and I expect inflation will moderate, which means liftoff is still some time off. That said, as I mentioned earlier, if my upside risk for inflation comes to pass, with inflation considerably above 2 percent well into 2022, then I will favor liftoff sooner than I now anticipate. A major consideration will be my judgment about whether inflation expectations are at risk of becoming “unanchored”—rising substantially and persistently above 2 percent.”
Fed Quarles (“How Long is Too Long? How High is Too High?: Managing Recent Inflation Developments within the FOMC’s Monetary Policy Framework”)
https://www.bis.org/review/r211105f.pdf
- “I think it is clear that we have met the test of substantial further progress toward both our employment and our inflation mandates, and I would support a decision at our November meeting to start reducing these purchases and complete that process by the middle of next year.”
- “”Transitory” does not necessarily mean “short lived.” “ […] “Supply constraints in production and distribution already have become more widespread and have lasted longer than most forecasters anticipated. As noted earlier, labor supply constraints are making it difficult for businesses to keep up with demand. This dynamic will continue to support robust wage growth, putting further upward pressure on prices. Moreover, there is evidence in the past couple of months that a broader range of prices are beginning to increase at moderate rates, and I am closely watching those developments.” […] “I am among those who see a good chance that inflation will remain above 2 percent next year, but I am not quite ready to conclude that this “transitory” period is already “too long.” “.
- “I do not see the FOMC as behind the curve, for three reasons: Most of the biggest drivers of the very high current inflation rates will ease in coming quarters, some measures of underlying inflation pressures are less worrisome, and longer-term inflation expectations are anchored, at least for now.”
- “The inflation we have experienced so far has been very unusual and largely related to supply constraints associated both with production and distribution problems related to COVID and with a demand shock arising from the unprecedented and rapid reopening of the economy.”
- “To get a fix on where inflation is headed, it is helpful to consider measures of inflation that try to filter out the most unusual and presumably transitory price increases that may be driving headline inflation. The Federal Reserve Bank of Dallas’s trimmed mean measure of inflation systematically removes prices that are increasing or decreasing at abnormally large rates, in order to get some perspective on underlying inflation pressures. For the 12 months through August, the Dallas trimmed mean inflation was an even 2 percent.”
- “That brings us to the third reason that I do not think the FOMC is behind the curve: anchored inflation expectations. We monitor longer-term expectations of future inflation because we believe they influence changes in actual inflation over the medium term. In fact, our new framework recognizes that stable, well-anchored inflation expectations help return inflation to 2 percent when it is running high, as it is now, as well as when it has fallen somewhat below that goal, as it often does during a recession.”
- “Going forward, the question is not only whether inflation will fall in the coming months, but also how far it will fall and if it will fall soon enough to avoid spurring a concerning rise in longer-term inflation expectations.”
- “Given the lags with which monetary policy acts, we could easily find that demand is damping just as supply is increasing, leading us to undershoot our inflation target—and, in the worst case, we could depress the incentives for supply to return, leading to an extended period of sluggish activity and unnecessarily low employment.” […] “We haven’t yet met the more stringent tests for liftoff that we have laid out in forward guidance about the federal funds rate.”
- However, “If inflation does remain more than moderately above 2 percent, be assured that the FOMC has the framework and the tools to address it.”.