Inflation forecasts - what to believe

Is the Fed doing a good job? One of the simplest measures is to see whether they are hitting their targets for inflation. We know there will always be some error with any forecast. We also know that the Fed's inflation forecast is for the longer-run. We should no put much stock in the short-run value. Still, the Fed is over its forecast number. While the Fed has clearly stated that it will not tighten soon, it is less clear whether there will be more quantitative easing. There are two important questions that have to be answered.

Are the price changes in commodities temporary? The commodity spike in the first half of last year was associated with price gains especially in the agricultural sector. Oil price have been a bigger concern this year. However, if geopolitical risks decline, there will less pressure on oil and gasoline. Commodity prices will move inflation closer to 2%

How much slack is there in the economy? This is a more complex question. There is still a large output gap but it is clear that some of the capital utilization may be understated.  Labor markets are starting to tighten for key sectors of the economy. The youth, the under-educated, and the old will have a difficult time finding work, but if you have key skills, the employment prospects are improving. If you believe that productivity gains will be limited, then we may have a floor on inflation. The chance of deflation is reduced. The 2009 environment is not likely.

Given a slow decline to 2%, there is some room for more easing, but it will not happen until we get the inflation rate below the target level.