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Tuesday, February 08, 2011

Fed's Lockhart on Inflation

by Calculated Risk on 2/08/2011 02:16:00 PM

From Atlanta Fed President Dennis Lockhart: Rising Prices, the Cost of Living, and Inflation. A few excerpts:

So what about inflation? I'll start with what the data tell us. The retail price measures jumped at year end as the price of gasoline rose. But looking beyond the rise in gasoline prices, consumer price increases remained exceptionally modest.
Yet inflation anxiety is rising. There seems to be a disconnect between what the Fed is saying and what people are experiencing when they fill up their gas tanks or read about rising food prices around the world.
I do think in the swirl of official statements and public discourse we may be talking about different things. To my way of thinking, the term "inflation" is misused in describing rising prices in narrow expenditure categories (for example, food inflation). Nonetheless, recent price news has encroached on the public consciousness with the effect that any price rise of an important consumption item is often taken as signaling inflation.
Let's review what inflation is and is not. Inflation affects all prices. Inflation is not the rise of individual prices or the rise of categories of prices.
The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food or provide health care. We cannot prevent the next oil shock, or drought, or a strike somewhere —events that cause prices of certain goods to rise and change your cost of living.

So monetary policy is not about preventing relative price adjustments dictated by market forces. It is about controlling the broad direction and pace of change of all prices across the economy.
Notwithstanding the energy-driven jump in prices in December, underlying inflation is currently below the level that I would define as price stability. My current projection shows underlying inflation gradually rising over the next few years, putting us back into a range consistent with the 2 percent target by 2013.
There is much more in the speech, but these excerpts touch on a few key points. There does appear to be a disconnect between what the Fed is looking at for monetary policy, and what the general public (and some politicians) are looking at. Monetary policy cannot control the price of oil or other commodities that are being driven up by supply and demand factors (as an example, monetary policy can't help with a drought in China and other food production problems).

The bottom line is the core measures of inflation are still very low, and it is very unlikely that the Fed will raise the Fed funds rates this year.