Fed Vice Chair Richard H. Clarida delivered a speech at the Symposium on Monetary Policy Frameworks (The Brookings Institution) today about “Flexible Average Inflation Targeting and Prospects for U.S. Monetary Policy”. Clarida reiterated three important points: (i) the Fed view on inflation (transitory, as supply-demand imbalances will resolve), (ii) long-term inflation expectations remain crucial to assess whether AIT has been met, and (iii) conditions for hiking are still far away (although they could be met “by year-end 2022”).
Please, find below the relevant points together with a comment for each point.
Note: on a separate subject, Vice Chair Randy Quarles has submitted his resignation from the Fed Board. According to our FOMC meter, Quarles could be seen as a median participant with no bias (neither dovish, nor hawkish). The administration will probably announce new appointments soon. At this point, it is possible to end up with a slightly more dovish FOMC compared to the recent composition.
Fed Clarida’s main points
Forecast for core PCE price inflation
What Clarida said: “Core PCE inflation surges to at least 3.7 percent this year before reverting back to 2.3 percent in 2022, 2.2 percent in 2023, and 2.1 percent in 2024. Thus, the baseline outlook for inflation over the three-year projection window reflects the judgment, shared with many outside forecasters, that under appropriate monetary policy, most of the inflation overshoot relative to the longer-run goal of 2 percent will, in the end, prove to be transitory.”
Comment: while we also expect a significant deceleration in the second half of 2022, we think that the risks are skewed to the upside, especially for 2021 (a 3.7 percent for core PCE in 2021 is a very generous assumption..).
Is high inflation transitory?
What Clarida said: “Although in a number of sectors of the economy the imbalances between demand and supply—including labor supply—are substantial, I do continue to judge that these imbalances are likely to dissipate over time as the labor market and global supply chains eventually adjust and, importantly, do so without putting persistent upward pressure on price inflation and wage gains adjusted for productivity.”
Comment: overall, we agree with Clarida. Nevertheless, we should stress that nobody seems to have a good model for global supply chains. The Fed Board staff has been surprised by how long it is taking to adjust. Therefore, we cannot exclude that continuing disruptions will, once again, last a bit longer than the Fed is anticipating.
Inflation expectations
What Clarida said: “[…] and so long as inflation expectations remain well anchored at the 2 percent longer-run goal—which, based on the Fed staff’s common inflation expectations (CIE) index, I judge at present to be the case.”
Comment: Clarida is fully onboard with the Fed staff view, including the Fed -CIE model. The good news is that we can provide you real-time updates of this model as new data become available.
Hiking
What Clarida said: “While we are clearly a ways away from considering raising interest rates, if the outlooks for inflation and unemployment I summarized a moment ago turn out to be the actual outcomes realized over the forecast horizon, then we believe that these three necessary conditions for raising the target range for the federal funds rate will be met by year-end 2022.”
Comment: the Fed staff (2021) post strategy review Taylor rule (see Figure below) -conditional on the September 2021 SEP forecast- implies 1 rate hike in the second half of 2022 (precisely, in 2022:Q3).
Figure 1 – Taylor rules conditional on September 2021 SEP forecasts
