Fed Chairman Yellen stated that the latest increase in inflation is "noise". The PCE was up 1.6 percent from a year ago and the CPI was up 2.1 percent.
So when do we have inflation signals versus noise? The simplest way to adjust for noise is to take out the components that are noisy. We often look at inflation ex food and energy given both are subject to supply shocks. The idea is that higher prices today will be offset or reversed tomorrow. To make this work, we have to expect that the noise will be offset in the future and that inflation is going to fall by the amount of the upward noise. If that does not happen, purchasing power is reduced. It is not clear that Yellen is saying this.
So when do we have inflation signals versus noise? The simplest way to adjust for noise is to take out the components that are noisy. We often look at inflation ex food and energy given both are subject to supply shocks. The idea is that higher prices today will be offset or reversed tomorrow. To make this work, we have to expect that the noise will be offset in the future and that inflation is going to fall by the amount of the upward noise. If that does not happen, purchasing power is reduced. It is not clear that Yellen is saying this.
If the recent inflation increase is just noise, then we can expect that no action will be taken which will be a green light for holding risky assets. As stated by Yellen, conflicts with employment or growth goals could be "somewhere down the road".
Just a variation of the classic, "Nothing to see here, move along".
Just a variation of the classic, "Nothing to see here, move along".
So if we put this together, what can we expect from policy. Here is Chairman Yellen with some forward guidance:
“we would consider, in deciding on a policy, just how far we are from achieving each of the objectives and if the distance from achieving an objective is particularly large, it would be consistent with the balanced approach that we would tolerate some movement in the opposite direction on the other objective.”
Got it. The Fed will let inflation go higher to reach other goals. Don't worry. Inflation is noise when the Fed says it is.
Remember "forward guidance" is not "formal guidance". We should be guided by the sum of all comments, and this one is telling us not to worry about inflation even if it is rising.
Remember "forward guidance" is not "formal guidance". We should be guided by the sum of all comments, and this one is telling us not to worry about inflation even if it is rising.
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