Inflation has been the big puzzle of the post-Financial Crisis period. This was the focused theme for the Kansas City Fed Jackson Hole conference. No speaker came out and said that we don't know the transmission mechanism for inflation, but the focus was on the fact that the link between the real economy, monetary policy, and actual inflation is variable. The lag relationships with past inflation are time varying, and the link between output gaps and inflation seem variable. Core inflation is variable and the shocks in oil or other commodity prices seem to have an unclear link with headline inflation. Unemployment is near the natural rate, but the link with wages and ultimately prices is not as responsive as in the past. Trimmed mean PCE may give us a stable inflation but this may not be the inflation faced by many consumers. The pass-through from exchange rates to inflation is also variable.
This does not even account for the formation of inflationary expectations and how this may feedback to actual inflation. Expectations have been stubborning low in spite of monetary policy that has flooded markets with credit.
The story for investors is that inflation does not seem to be responsive to policy or to normal forecasting even if we can decompose a good portion of the low inflation to slack demand. It seems as though the Fed is not emphasizing inflation forecasts as a key determinant in policy. Asset market volatility and international developments seem to have a greater focus at this time.
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