Sunday, October 4, 2015

Yellen inflation - complex problem with no easy solutions



Reviewing the Yellen speech on inflation provided context but not enlightenment on the current inflation problem. There has been smooth transition to lower inflation levels that have been sticky since 2000. This was the success of the Fed in generating creditability and breaking inflation expectations in the 1980's, yet now we look at this as a failure. The core inflation rate has fallen below the 2% level even with all the QE efforts to flood the monetary system.

Still there seems to be good reasons for the current fall in inflation. The combination of lower energy costs and import prices not slack seem to be the drivers in 2015. This would suggest that the decline is temporary and the Fed should start its lift-off. The relative import prices is from a stronger dollar.  An increase in rates is not going to have that issue go away, but some of the import price issue is related to policies with other central banks.  By the Fed's calculation, slack in the economy has fallen significantly as a attribute for the decline in inflation.


The Yellen speech actually provides good reason for us to believe that the sub-2% inflation is something that will not last. Inflation expectations are well centered above the current inflation numbers so there is not a threat of deflationary expectations that will slow investment and spending decisions. While the inflation information is useful, it sends mixed signals on how the Fed uses its models and information. 

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