speeches · February 19, 2008

Speech

William Poole · President

Inflation Dynamics TheBaldwinLecture TrumanStateUniversity Kirksville,Missouri February20,2008 The U.S. economy today is limping icsamongprofessionaleconomists.Ononeside along. Some believe recession is at ofthediscussionwereMiltonFriedmanand hand; others, and I include myself in economistsof“ChicagoSchool”persuasionwho this group, believe the economy will arguedthattrendinflationwasalwaysandevery- skirt recession. The difference in view may not whereamonetaryphenomenon.Analternative be very large, as an economy growing at a barely perspectivewasthe“Phillipscurve”viewthat positive rate will look and feel about the same theleveloftheunemploymentratewastheprin- as one with output falling slightly. cipaldeterminantoftherateofinflation.From InrecentspeechesIhavediscussedanumber thatperspective,policyactionsreducingthe ofissuesrelatingtotheeconomicoutlook,includ- unemploymentratewereseentoprovokeaper- ingespeciallyproblemsinthemortgagemarket manentincreaseintherateofinflation.Athird andtheprocessbywhichtheeconomywillin viewatthetime,frequentlyincorporatedinto timerestoregreaterstabilitytofinancialmarkets. thePhillipscurveperspective,wasthatinstitu- TodayIwilldiscussinflation.FederalReserve tionalstructuressuchasthemarketpowerof policyisalwaysandunavoidablyabalancingact concentratedfirmsoverpricesoroflaborunions betweenunemploymentconcernsandinflation overwagesalsocontributedtoupwardtrendsin concerns.Thereisnoquestionthatinpopular thegenerallevelofprices. debatestodaytheriskofhigherunemployment Inthelate1960s,MiltonFriedmanand istheNo.1concern,butmyreadingofeconomic EdmondPhelpsintroducedtheexpectations- historyisthatwegenerallylivetoregretamone- augmentedPhillipscurveandtheconceptofthe tarypolicyfocusedexclusivelyontheNo.1eco- naturalrateofunemployment.Underthishypoth- nomicconcernoftheday. esis,thereisnopermanenttrade-offbetween Beforeproceeding,Iwanttoemphasizethat unemploymentandinflation.Anytrade-offisat theviewsIexpressherearemineanddonot besttransitory,andreductionsinunemployment necessarilyreflectofficialpositionsoftheFederal gainedthroughincreasedinflationdisappearas ReserveSystem.Ithankmycolleaguesatthe privateagentsadjusttheirexpectationsabout FederalReserveBankofSt.Louisfortheircom- futureinflationtothenewinflationenvironment. ments.RobertH.Rasche,seniorvicepresident Oncethisadjustmentofexpectationshasoccurred, anddirectorofresearch,providedspecialassis- allthatisleftwouldbethenewhigherinflation- tance.However,Iretainfullresponsibilityfor aryenvironment.Intheearly1970s,thistheory errors. gainedwideacceptanceamongacademicecono- mists,thoughitsacceptancebypolicymakers wasslower. TRENDS IN INFLATION Asthisdiscussiononinflationprocesses Fortyto50yearsago,thesourcesanddynam- wasevolving,theoilpriceshocksof1973-74 icsoftrendsininflationwerehotlydebatedtop- and1979occurred.Initiallytheseshockswere 1 MONETARYPOLICYANDINFLATION viewedascontributingtoinflationtrends.Over stabilityisbothagoalandanintermediate time,though,economistscametobelievethat targetofpolicy.AsIwilldiscuss,whenprices supplyshocksthatcausedlargechangesinrela- arestable,botheconomicgrowthandstability tiveprices—evenverypersistentorpermanent arelikelytobeenhanced,andlong-terminter- estratesarelikelytobemoderate.Thus,even changesinrelativeprices—couldhaveonlytran- apolicymakerwhoplacesrelativelylessweight sitoryeffectsontheinflationrateunlessaccom- onpricestabilityasagoalinitsownright modatedbymonetarypolicy. shouldbecarefultomaintainpricestabilityas Aslateas1979,formerFederalReserve ameansofadvancingothercriticalobjectives.2 ChairmanArthurBurnsattributedtheongoing riseofinflationtofundamentalchangesinsocial Themechanismsthroughwhichcentral institutionsandvalues.Burnsarguedthatthese bankspursueaninflationobjectivearevaried.In changesproduced the1970sand1980s,themonetaristperspective, followingMiltonFriedman,wasthatcentral …apersistentinflationarybiasthathas banksmusttargetlowandstablemonetarygrowth. emergedfromthephilosophicandpoliticalcur- Ifthecentralbankestablishedsuchapolicy rentsthathavebeentransformingeconomic regime,alowandstabletrendrateofinflation lifeintheUnitedStatesandelsewheresince the1930s.Theessenceoftheuniqueinflation wasexpectedtofollow.Thecontrolledgrowth ofourtimesandthereasoncentralbankers rateofthemoneystockwouldprovidethenomi- havebeenineffectiveindealingwithitcan nalanchorfortheeconomy. beunderstoodonlyintermsofthosecurrents Inthelatterpartofthe19thcentury,most ofthoughtandthepoliticalenvironmentthey Westerncentralbankssubscribedtothegold havecreated.1 standard.Inthisenvironment,pricestendedto Bythe1980s,thehypothesisthattrendinfla- fluctuatearoundaconstantlevel.Certainlythere tionwasamonetaryphenomenonhadgained werechangesinthepricelevelfromyeartoyear, almostuniversalacceptanceamongeconomists sometimesquitesubstantial,butsuchchanges andpolicymakers.FedChairmanPaulVolcker tendedtobereversed.Theaveragetrendininfla- appliedmonetarymedicinetotametheinflation tionwasclosetozero.Thegoldstandardpro- ofthe1970sandby1984achievedaroughlysta- videdanominalanchorfortheseeconomies.If blerateofinflationintheneighborhoodof4per- centralbanksadheredtotherulesofthegold centperyear.Theexperienceandpainofthe standard,goldflowedoutofacountrywhenits Volckerdisinflationplustheemergingtheoretical pricelevelroseandintoacountrywhenitsprice consensusamongeconomistsledcentralbankers levelfell.Whenthesegoldflowswereallowed throughouttheworldtoconcludethattheprimary tofeedthroughtothestockofmoney,aswas responsibilityofmonetarypolicyistomaintain supposedtobethecaseunderthegoldstandard, pricestability.EvenintheUnitedStateswhere changesindomesticpriceswerereversedover legislationexplicitlydefinesa“dualmandate” time.Hence,thegoldstandardmaintainedprice fortheFederalReserveSystem,theprimacyof stabilitythroughautomaticadjustmentsofthe thepricestabilitygoalisacknowledged.For moneystock.Themoneystockwasnotitselfa example,inhisfirstspeechafterhisswearing-in, policytool,butthepolicyruleinplace—thegold ChairmanBernankestated: standard—generatedtherequiredadjustmentof themoneystocktorestorepricestability. Althoughpricestabilityisanendofmonetary policy,itisalsoameansbywhichpolicycan Inthelate1980s,aftertheVolckerdisinflation achieveitsotherobjectives.Inthejargon,price andinresponsetoawidespreadacceptanceof 1 A.F.Burns,“TheAnguishofCentralBanking,”PerJacobssonLecture,BelgradeYugoslavia,September30,1979,p.9. 2 “TheBenefitsofPriceStability,”February24,2006.<www.federalreserve.gov/newsevents/speech/bernanke20060224a.htm>. 2 InflationDynamics thetheoryoftheexpectations-augmentedPhillips CONTROLLING INFLATION curve,centralbankersacknowledgedtheir Theissuetodayislessaboutthedesirability responsibilitytoprovideanominalanchorfor ofcontrollinginflation,orabouttheappropriate theireconomies.IntheUnitedStates,Chairman inflationtargetrange,thanaboutthespecification Volckerand,followinghim,ChairmanGreenspan ofamonetarypolicytoachievetheagreedobjec- definedpricestabilityasaninflationratesuffi- tivesoflowinflationandahighlevelofemploy- cientlylowthatbusinessesandhouseholdsdid ment.In1993,StanfordeconomistJohnTaylor nottakeitintoconsiderationintheirday-to-day proposedasimpleequationasanapproximate economicdecisions.InJanuary1988,thethen descriptionofthesystematicpolicyofthe governoroftheBankofCanada,JohnCrow, GreenspanFedtothatdate.TheFOMC,then deliveredapubliclectureinwhichhestated andnow,conductspolicybysettingatargetfor that“pricestabilitywassetoutexplicitlyasthe theovernightfederalfundsrate,whichisthe Bank’sprimeobjectiveand,realistically,theonly interestrateonone-dayloansintheinterbank thingthatitcoulddeliverwiththetoolsatits market.FromhisstudyoftheFOMC’sactual disposal.”3In1990,theReserveBankofNew behavior,Taylorconcludedthatthecommittee Zealandbecamethefirstofficialinflation-targeting hadadjusteditstargetforthefederalfundsrate centralbankwhenitnegotiatedanagreement inresponsetothreeelements:1)atargetordesired withthegovernmentthatspecifiedanumeric rateofinflation;2)deviationsoftheactualinfla- inflationobjectiveformonetarypolicy. tionratefromthetargetrate;and3)deviationsof InthejudgmentofGovernorCrow’ssucces- realoutput(GDP)fromameasureoftrendor sorattheBankofCanada,GovernorGordon “potential”output.Taylorincorporatedthese Thiesson,thestatementofhispredecessorwas considerationsinaspecificequation,nowwidely inadequateasapolicyobjectivebecause“price knownasthe“Taylorrule.”Subsequentanalysis stability,althoughoftenreferredto,wasnot,how- showedthatacentralbankthatfollowedsucha ever,clearlydefined.”4Subsequently,inFebruary policyrulewithasufficientlyaggressiveresponse 1991,theBankofCanadaandtheCanadianmin- todeviationsofactualinflationfromthetarget isteroffinanceintroducedexplicitinflation levelwouldprovideanominalanchorforthe reductiontargetsintheNewZealandstyle.In economy. subsequentyears,moreandmorecentralbanks AcriticallyimportantpartofTaylor’sanalysis adoptedsuchnumericinflationtargets,including wasthedistinctionbetweentherealandnominal theSwedishRiksbank,theBankofEnglandand rateofinterest.Thenominalrateofinterestis theEuropeanCentralBank.WhiletheFederal observeddirectlyinthemarket.Atpresent,for OpenMarketCommittee(FOMC)—theFederal example,theFOMC’stargetforthefederalfunds Reserve’smainmonetarypolicymakingbody— rateis3percentandtheactualrateinthemarket hasnotadoptedanexplicitnumericinflation isclosetothistarget.Therealrateofinterestis target,manyindividualFOMCparticipantshave thenominalratelesstheexpectedrateofinflation. beenquiteforthrightabouttheirviewsonprice Whentherateofinflationexceedsthenominal stabilityor“comfortzones”forinflation.Iamon rateofinterest,alenderisactuallysubsidizinga recordasfavoringatargetintermsofthepersonal borrowerbecausealoanisrepaid—principaland consumptionpriceindexof1.5percentannual interesttogether—withdollarsoflowerpurchas- rateofincreaseplusorminus0.5percent. ingpowerthanthoseoriginallylent. 3 G.G.Thiesson,“CanaBankChange?TheEvolutionofMonetaryPolicyattheBankofCanada1935-2000,”BankofCanada,TheThiesson Lectures,p.76.<www.bank-banque-canada.ca/en/pdf/thiessen-eng-book.pdf>. 4 Ibid. 3 MONETARYPOLICYANDINFLATION Recallthatthegoldstandardautomatically GDParecloselyrelated.TheTaylorrulecallsfor checkedinflationbecauseacountryexperiencing thecentralbanktoreduceitsinterestratetarget inflationwouldlosegold,whichwoulddepress whenGDPdropsbelowpotential,andthelarger themoneystockandtendtoreturntheprice thegapbetweenactualandpotentialGDP,the leveltoitsinitialstate.UndertheTaylorrule,a largeristhereductioninthetargetinterestrate. similarmechanismwouldbeatwork,provided Thereisasubstantialliteratureexamining thecoefficientsintheequationdefiningtherule howtosetthecoefficientsontheinflationand wereappropriate.Forthepolicyruletoproduce realGDPtermsintheTaylorequationtoachieve thedesiredresults,acentralbankhastoraiseor thebestpossiblebalancebetweenthegoalsof loweritsnominalinterestratetargetenoughso lowinflationandhighemployment.Researchers thattherealrateofinterestrisesorfallsin havealsoexaminedotherissues,suchaswhether responsetoinflationaboveorbelowtheinflation apolicybasedonforecastsofinflationandreal target.Forexample,iftheinflationratewereto GDPworksbetterthanonebasedonthemost risebyonepercentagepoint,theFOMCwould recentactualreadingsofthesevariables.The havetoraiseitstargetfederalfundsratebyone complexitiesareconsiderable,inpartbecause percentagepointjusttokeeptherealrateof firstreleasesofdataaresubjecttorevisionand interestunchanged.AtypicalTaylorrulespeci- forecastsaresubjecttosubstantialerrors. ficationwouldcallfortheFOMCtoincreaseits TheFOMC'sdecisionsareinformedbythe targetfedfundsrateby1.5percentagepointsto Taylorruleandtheextensiveresearchbehindit. ensurethattherealrateofinterestactuallyrises However,thecommitteedoesnotfollowtherule wheninflationrises. precisely,asitcanbringotherconsiderationsto Ifthemoney-demandfunctionwerestable,a bear,suchasknowledgeofthestateofthefinan- centralbankthatpursuedsuchaninterestrate cialmarketsandawidevarietyofotherinforma- policywouldfindthatthegrowthrateofthe tion.Agreatdealisknownaboutinflation moneystockwouldfallwheninflationroseabove processesthatcannotatthistimebeincorporated target.Similarly,undertheTaylorrulemoney inaTaylor-typeequationinapreciseway.Abasic growthwouldtendtorisewheninflationfell understandingofinflationdynamicsisimportant belowthetarget.Ifacentralbankissuccessfulin tounderstandingFOMCpolicy.Itistothissub- maintainingarelativelylowrateofinflation,the jectthatInowturn. resultingaveragegrowthinthemoneystockwill berelativelylowandstable.Hence,acentralbank followinganappropriatelyspecifiedTaylorrule SHORT-RUN INFLATION withaninvariantinflationtargetwouldinduce DYNAMICS—DEVIATIONS FROM thepatternofmoneygrowththatthemonetarists TREND INFLATION arguedwasrequiredforanominalanchorinthe economy.TheTaylorrulereconcilessomewhat Aconvenientframeworkfororganizinga differenttheoreticalapproachesofeconomists discussionofshort-runinflationdynamicsisthe whoemphasizethemoneystockintheiranaly- expectations-augmentedPhillipscurvethatI sisofmonetarypolicyandthosewhoemphasize mentionedpreviously.Inadiagramwiththerate interestratesintheiranalysis. ofinflationontheverticalaxisandtherateof Ihavebeenemphasizingtheinflationpartof unemploymentonthehorizontalaxis,picturea theTaylorrule,butitisimportanttoputequal linedrawnsothatahigherrateofunemployment emphasisontherealGDPpart.Somespecifica- isassociatedwithalowerrateofinflation.This tionsoftheTaylorrulesubstitutetheunemploy- linereflectsashort-runsituation.Inthisframe- mentrateforrealGDP,butforpresentpurposes work,economistsidentifythreesourcesofinfla- thetwoareequivalentgiventhatunemployment tiondynamics.First,therearepermanent,or andthedeviationofrealGDPfrompotential semi-permanent,changesintheinflationrate 4 InflationDynamics resultingfromchangesinexpectationsheldby especiallyheadlineinflationoverthenextfew consumersandfirmsaboutfutureactualratesof years.5(Italicsadded) inflation.Inthetextbookgraph,aone-timechange RecentresearchattheFederalReserveBank intheexpectedrateofinflationisreflectedina ofSt.Louissuggeststhatsuchmovementsalong long-lastingshiftupordownintheshort-run ashort-runPhillipscurveortransitoryshiftsup relationbetweentheinflationrateandtheunem- anddowninthatcurveonlyaccountforarela- ploymentrate,ormoregenerallytherateofuti- tivelyminorportionoftheobservedinflationin lizationofresources.Therelevantvariableisthe theUnitedStatessincethemid1950s.Thedom- gapbetweentheactualandnaturalrateofunem- inantfactorinU.S.inflationhistoryoverthepast ployment,orbetweenthelevelofGDPandpoten- 50yearshasbeenchangesininflationexpecta- tialGDP.Second,therearetransitorychangesin tions,orsemi-permanentshiftsupanddownin theinflationratethatresultfromchangesinthe theshort-runPhillipscurve.Whenitcomesto rateofresourceutilizationintheeconomy.A theforcesbehindU.S.inflation,expectations transitorychangeisrepresentedbyamovement trumpthegap.6Whilesomeobserversmightbe alongashort-runPhillipscurve.Third,thereare startledbythisconclusion,reflectiononthe transitorychangesininflationasaresultoftem- broadoutlineofoureconomichistoryshould poraryshiftsupordownintheshort-runPhillips allayanyapprehensions.Inthe1960sand1970s, curvebecauseof“supplyshocks”ormoregener- successivebusinesscyclepeakshadbothhigher allychangesinrelativeprices.Typically,such inflationandhigherunemploymentrates, changesareidentifiedasshockstofoodorenergy explainedbyincreasesininflationexpectations. prices,thoughtheycouldresultfromchangesin Aftertherecessionof1990-91,bothinflationand manyotherrelativeprices.Exampleswould unemploymenttrendeddownfortheremainder includechangesinnominalexchangeratesthat ofthedecade.Inthetextbookparadigm,such alterpricesofimportedgoodsrelativetodomes- patternscanonlybeproducedbyshiftsinthe ticallyproducedgoodsorcertaindomestictax short-runPhillipscurvegeneratedbychangesin changes.Measuresof“coreinflation,”whichI inflationexpectations.Indeed,directevidence willdiscussinafewminutes,inprincipleare oninflationexpectationssuggeststhatexpecta- designedtofilteroutveryshort-runmovements tionsdidtrendgraduallydownoverthe1990s. ininflationoriginatingfromsomeofthesesources Theconclusionthatexpectationstrumpthe inordertogivebetterinsightintofundamental gapingeneratinginflationisextremelyimpor- forcesaffectingtheinflationrate. tantformonetarypolicy.Itimpliesthatlowand Theeffectsofsupplyshocksandresource stableinflationwillonlybeobservedwhenthe utilizationweighonthemindsofpolicymakers privatesector’sexpectationsofinflationare aswitnessedbyacommentinminutesofthe solidlyentrenchedatalowlevel. December2007FOMCmeeting: Participantsthoughtthatrecentincreasesin energypriceslikelywouldboostheadline MEASURING INFLATION inflationtemporarily,butwithfuturesprices EXPECTATIONS pointingtoagradualdeclineinoilpricesand Ifexpectationsaboutfutureinflationheldby withpressuresonresourceutilizationseenas likelytoeaseabit,mostparticipantscontinued householdsandfirmsareacriticaldeterminant toanticipatesomemoderationincoreand ofactualinflation,thenhowcanpolicymakers 5 FederalOpenMarketCommittee,“MinutesoftheMeetingofDecember11,2007,”p.5.<www.federalreserve.gov/monetarypolicy/files/ fomcminutes20071211.pdf>. 6 J.M.PigerandR.H.Rasche,“Inflation:DoExpectationsTrumptheGap?”FederalReserveBankofSt.LouisWorkingPaper2006-013B. 5 MONETARYPOLICYANDINFLATION monitorsuchexpectations?Inthepast20years, percent.Thesurvey-andmarket-basedmeasures surveymeasuresofexpectationsofinflationat arequiteconsistent. longerhorizonshavebecomeavailable.Thebest Fromthisevidence,wecanconcludethat knownofsuchmeasuresisthesurveyofprofes- thecurrentsituationisoneofsubstantialstabil- sionalforecastersconductedbytheFederal ityofinflationexpectations.Thisobservationis ReserveBankofPhiladelphia.Thissurveyhas extremelyimportant,becauseoftheevidencethat, beenconductedquarterlysincethefourthquarter historically,changesininflationexpectations of1991andfocusesonexpectationsof10-year havebeenbyfarthelargestdriverofchangesin averageCPIinflation.Therespondentsampleis theactualrateofinflation.Recentrelatively relativelysmall.7 smallincreasesininflationareapparentlydueto Adecadeago,theU.S.Treasurystartedissuing transitoryfactorsandnottochangesininflation bondsthatareindexedtotheCPI.Overtime,new expectations.Ofcourse,theFOMCmustcontinue issuesofthesesecuritiesbecameavailableona topursueamonetarypolicythatisconsistent regularcalendarandmarketliquidityimproved. withwell-anchoredinflationexpectations. Itisnowpossibletoobservethedifference betweentheyieldsonconventionalnominal Treasurybondsandindexedbondsofcompara- CORE VERSUS HEADLINE blematurity.Theyielddifferencetypicallyis INFLATION referencedas“inflationcompensation”since,in Ihaveemphasizedtheimportanceofdistin- additiontomeasuringexpectationsinfinancial guishingtemporaryfromlonger-lastingchanges marketsaboutfutureinflation,theratespread intherateofinflation.Theconceptof“core” betweenconventionalandindexedbonds inflationisanefforttomakethedistinctionmore includesapremiumtocompensatefordifferences precise. inliquiditybetweenthetwotypesofbondsand Theoriginsofcoremeasuresofinflationare apremiumtocoverinflationrisk. somewhatobscure.Asearlyas1957,theBureau Asanaside,inflationcompensationinthe ofLaborStatistics(BLS)publishedaspecialcon- bondmarketseemstometobeamorereliable sumerpriceindexexcludingfood.8Presumably, measureofinflationexpectationsthansurvey therationaleforthispriceindexwasthat,inthe information,becauseinvestorshaveputmoney short-run,foodpricesarehighlyvolatileandare ontheirexpectationsandnotjustananswerona affectedbyweatherandagriculturalproduction surveyform.Thedisadvantageofthebondmar- conditionsthatareindependentofthefundamen- ketmeasureisthatexperiencedatesbackonlyto talforcesdrivingtheoverallrateofinflation.In 1997,whentheU.S.Treasuryfirstissuedinfla- 1973-74theU.S.economyexperiencedanoil tion-indexedbonds. priceshockwhenOPECimposedanembargoon Long-terminflationexpectations,asmeas- oilshipmentstotheUnitedStates.Beginningin uredbythesurveydata,trendedsteadilydown 1977,theBLSstartedpublishingaspecialCPI throughtheearly1990sandthenstabilized. priceindexexcludingfoodandenergyprices.9 Theyhavedifferedlittlefrom2.5percentsince Suchindexeshavebecomeknownas“core” 1998.Inflationcompensationinthebondmarket priceindexes. waslessthan2percentinearly2003butthen Docoremeasuresofinflationgiveabetter roseand,sinceearly2004,hasbeenaround2.5 measureoflonger-runinflationtrends?Iftherel- 7 Recentsurveyshaveabout50respondents.Attimesinearlieryearsthesamplewasconsiderablysmaller. 8 AspecialCPIpriceindexforallitemsexcludingfoodfirstappearedintheMonthlyLaborReviewofJuly1957,TableD-3. 9 AspecialCPIpriceindexforallitemslessfoodandenergyfirstappearedintheApril1977issueofthepublicationCPIDetailedReport. 6 InflationDynamics ativepricesoffoodandenergydisplayhigh- myviewisthatpolicymakersshouldrelyonthe frequencytransitorycomponents,thenthese judgmentofthemarketsunlesswehavesolid measureslikelyprovideusefulinsights.However, evidencethatthemarketsarewrong.Mypersonal thesepricesmaynotalwaysdisplaysuchchar- experienceisthat,althoughthemarketsobviously acteristics.EconomistsattheSt.LouisFedhave canbewrong,Ihavenoconfidencethatmyown notedthat,since2003,inflationasmeasuredby judgmentonsomethinglikeoilpriceswillbe thecorepersonalconsumptionpriceindexhas systematicallymoreaccurate. beenconsistentlylowerthaninflationmeasured bytheheadline,ortotal,personalconsumption priceindex.10 PERSISTENCE OF FLUCTUATIONS Itdoesnotseemlikelythatcoremeasuresof AROUND TREND INFLATION inflationwereintendedtofilterouttheimpact Howmuchpersistencewillweobservein ofsustainedtrendsinrelativepricesfromthe departuresfromtrendinflation?Frommydiscus- measurementofoverallinflation.Certainlythe sionabove,onecriticalelementintheanswerto relativepricesofcomputersandconsumerelec- thisquestionishowsensitiveinflationexpecta- tronicshavebeenfallingformanyyears,even tionsaretoactualchangesininflation.Persistence withoutadjustmentsforqualitychanges.Noone, ofinflationexpectationsisnotindependentof tomyknowledge,hasproposedremovingthe marketperceptionsastohowthecentralbankis pricesofcomputersandconsumerelectronicsto pursuingitsinflationobjective.Ifactualinflation measurecoreinflation.Theeconomicforcesat deviatesfromexpectedinflation,andhouseholds workherearetrends,nothigh-frequencytransi- andfirmsbelievethatthecentralbankwill toryfluctuations.Coulditbethattherearenow moveaggressivelytorestoreinflationtoawell- trendsinplaceintherelativepricesoffoodand understoodinflationtarget,thentherewillbe energy?Iamnotpreparedtodismissthispossibil- littlereasonforthemtoadjusttheirlonger-run ity.RapideconomicdevelopmentinChinaand inflationexpectations.Marketswillthenhelp Indiahasplacedincreaseddemandontheworld thecentralbanktominimizethepersistenceof capacitytoproducebothfoodandenergyand theinflationfluctuations.If,however,households thereforehassurelycontributedtothepersistent andfirmsperceivethatthecentralbankwillnot gapbetweencoreandheadlineinflationnumbers moveaggressivelyagainstanunwelcomechange observedoverthepastfiveyears.Itisnotunrea- ininflation,thentheymayadjusttheirlonger-run sonabletoforecastthatincreaseddemandforfood inflationexpectationsand,indoingso,amplify andenergybyemergingeconomieswithlarge andmakemorepersistentthechangeininflation. populationswillcontinueforaconsiderable Theinflation-fightingcredibilityofthecentral period.ThispossibilitysuggeststheFOMCmust bankisacrucialfactor,perhapsthemostcritical exercisecautionlestmonetarypolicyinadver- factor,inshort-runinflationdynamics. tentlyaccommodateanincreasedinflationtrend byfocusingonthebehaviorofpriceindexes excludingfoodandenergy. CONCLUDING COMMENT Althoughthedangerisreal,itisalsotrue thatoilfuturespricesforcontractsseveralyears Ibeganmyremarksbynotingthatweare aheaddonotsuggestcontinuingincreasesinoil likelytoregretamonetarypolicythatconcen- pricesofthemagnitudeobservedoverthepast tratesontheNo.1economicconcernoftheday fiveyears.Thatwasalsotruefiveyearsago—the totheexclusionofotherconcerns.Ibelievethat futuresmarketturnedouttobewrong.However, theFOMCinrecentyearshaspursuedapolicy 10SeeJ.B.BullardandG.Pande,“EnergyPrices:IntheMixorSweptundertheRug?”FederalReserveBankofSt.LouisNationalEconomic Trends,April2007,p.1.<www.research.stlouisfed.org/publications/net/20070401/cover.pdf>. 7 MONETARYPOLICYANDINFLATION thatisbroadlyonasoundtrack.Iamwillingto advance,anditisnotalwayseasytoseetheseeds quibbleondetails,andhave,butnotonfunda- astheysprout.Inpresentcircumstances,mone- mentals. tarypolicymakerswillneedtobecarefultoreact Thereareinsistentdemandsbysomethat toevidenceonthestateoftheeconomyandlikely theFOMCdomore.AttheCommittee’smeeting outlookforemployment.Theissueislikelydevel- nextmonth,whichIwillnotattendasIamretir- opmentsinthelabormarketandnotmerely ingfromtheSt.LouisFedshortlyafterthatmeet- possibledevelopments.Atthesametime,policy- ing,furthercutsinthetargetfederalfundsrate makerswillhavetoremainconsciousoftheles- mayormaynotbeappropriate.Thedataonwhich sonsofhistorywithregardtoinflation.Here theFOMCwillbaseitsdecisionwillnotbefully again,likelydevelopmentsandnotjustpossible availableuntilthetimeofthemeeting. developmentsmustbethefocusofattention. ImustsaythatIamabittroubledthatIhear Riskmitigationtocountercostlypossible loudclaimsthattheFOMCdidnottightenpolicy developmentsisanimportantstrategy,buttaking enough,andsoonenough,in2004-05tochoke outinsuranceagainstcertainrisksisnotfree.At offthebubbleinhousepricesandunwiselend- anygiventime,policymakerscouldpursuea inginthesubprimemortgagemarket,develop- powerfullyexpansionarypolicytoallbutelimi- mentsthatareattherootoftoday’sproblems.I natethepossibilityofasignificantrecessionin donotrecallmanyloudandinsistentvoicesfor theyearahead,butdoingsowouldcomeatthe tighterpolicyatthattime.Policymakersarenot costandevenlikelihoodofanunacceptable clairvoyant.IwishIhadseentheseunfortunate increaseintherateofinflation.Weknowthat developmentsinthehousingmarketintheir inflationdoesnotbuyapermanentreductionin earlystages,butIdidn’t. unemployment.Indeed,asubstantialincreasein Mygeneralapproachistothinkaboutallthe therateofinflationpromisesalargerrecession thingsthatmighthappen,asbestIcan,andthen later,asthecountrylearnedatsuchgreatcostin trytodeterminewhatisactuallyhappening.My the1970s. analysisincludesmyunderstandingoflessons Monetarypolicyisabalancingact.Decisions fromhistory.Withregardtoinflation,weknow mustbebasedongoodeconomictheoryandthe thatinflationisamoreslowlymovingprocess mostcompleteinformationpossible.That,inmy thanisunemployment,butalsomorepersistent experienceoverthepast10years,isexactlywhat andmoredifficulttoturnaround.Theseedsof theFOMCdoes. aninflationproblemaresownseveralyearsin 8

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APA

William Poole (2008, February 19). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20080220_poole

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@misc{wtfs_speech_20080220_poole,
  author = {William Poole},
  title = {Speech},
  year = {2008},
  month = {Feb},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20080220_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}