Ignoring Inflation Worries, Janet Yellen Stays the Course

by Patrick Brennan

The Federal Reserve’s Open Market Committee released its latest policy statement today, and despite headlines suggesting that inflation may be ticking up, the committee didn’t tighten policy tighten anymore than it had planned to. Last week, Federal Reserve chairman Janet Yellen’s British counterpart, Mark Carney of the Bank of England, suggested that he’s considering hiking interest rates sooner than markets expect. But Yellen didn’t follow suit today: The Fed’s quantitative-easing program will continue to be “tapered” at the expected rate, $10 billion per meeting, and the members of the Fed committee’s plans for their first hike in interest rates (currently hovering around 0 percent) haven’t changed much at all.

There was so little new in the Fed’s statement, in fact, that people were talking about how the committee’s expectations for unemployment in the long run shifted from between 5.2 and 5.6 percent to . . . between 5.2 and 5.5 percent.

Joe Weisenthal of Business Insider says this is confirmation that Yellen is a dove — that is, someone who is more willing to use monetary policy to boost the economy and less worried about inflation rising than monetary “hawks.” He’s correct in a way, noting that this is just confirmation of what we thought about her. But Yellen still isn’t dovish enough for many: Vox’s Matt Yglesias makes the case today that Yellen should reverse the “taper” of quantitative easing, and go back to a more accommodative monetary policy.

That’s an extreme view. But it is a reminder that what Yellen did is not that dovish: She stuck to the taper in the face of jumpy inflation headlines and indications from other countries that they’re going to tighten policy. Why isn’t this that big a deal? Well, in part because the headlines about the return of inflation have been overstated. The Consumer Price Index — the core version, which leaves out highly volatile things like fuel — has seen an uptick recently:


But while this could be meaningful, there are a number of problems: First, it could just be statistical artifact. What really matters is long-term projections about inflation, and both the market and the Federal Reserve believe that inflation is going to rise slowly, but stay subdued in absolute terms. The Cleveland Federal Reserve Bank does a detailed update of inflation expectations each month based on market data. Now, their charts are from Cleveland so they’re not great, but here’s what’s called the inflation curve, what people expect inflation to be one through ten years out, and in the long term:


For the next ten years, in other words, people expect the headline inflation number (CPI) to remain under 2 percent. Only in the very long term, though that could change, do they expect it to rise above 2 percent, and there’s no recent sign the markets think that’s changing. Expectations for the amount of inflation that will occur over the next ten years remains subdued:

Again, these things could change — some very clever people, like Martin Feldstein, think they could change really rapidly, though such predictions have been made consistently the last few years and have proved incorrect. But the issue here is more than just headlines versus long-term expectations: The Fed doesn’t rely on the headline inflation numbers, the Consumer Price Index and its “core” version, but instead prefers the PCE index. Among other differences, the PCE index is “chained,” meaning it constantly takes into account changes in people’s purchasing patterns.

The PCE index remains below 2 percent, even as CPI has risen above it. I’m sure there are more skeptical views of why the Fed looks at the inflation the way it does, and there is at least one problem, in my opinion, with Yellen’s view of it: She seems willing to tolerate, even desirous of, inflation rising, because it could come in the form of higher wages that will draw long-term-unemployed workers back into the labor force. I’m skeptical that this is a surefire strategy. (Although there is some evidence the long-term unemployed are in fact remaining somewhat attached to the labor market, which is one necessary premise for Yellen’s optimism — so, point for her.) In any case, though, that’s a dovish belief of Yellen’s, in some sense — holding Fed policy steady when there are a few hot months of inflation isn’t.