24 Briefing Inflation TheEconomistJuly10th 2021
A little of what you fancy
United States, contribution to core inflation*
Percentage points
Source:GoldmanSachs
3
-0.2 0 0.2 0.4 0.6
May 2021 2000-1average
Hotels
Recreational services
New cars
Recreational goods/vehicles
Transport
Other services
Food services
Furnishings
Clothing
Non-profits
Housing
Financial services
Medical services
Used cars
*Personal consumption
expenditures index
economies and labour markets rebound,
there might be some catching up and—if
house prices are anything to go by—some
overshooting yet to do. Rent accounts for
onefifth of core inflation in the index tar
geted by the Federal Reserve.
Wages, rents and the like would have to
keep on increasing rapidly for high infla
tion to persist. This might happen if the ex
perience of the pandemic has changed the
givens of the economy in some deep way—
say, by permanently increasing the rate of
unemployment at which wages and prices
start to accelerate. But a more likely route
to persistently high inflation would be a
cycle of selffulfilling expectations.
So far, inflation expectations have not
risen by anything like as much as inflation
itself. Take financial markets. It is fashion
able to pay close attention to investors’ in
flation expectations as revealed by the dif
ference in price between inflationprotect
ed bonds and the normal kind. Expecta
tions rose steadily after President Joe
Biden’s election victory, which brought
with it the prospect of more stimulus. Re
cently, however, they have fallen back to
levels that are more or less consistent with
the Federal Reserve’s inflation target.
In the euro area investors still expect
the ecb to undershoot its inflation target
over the next five years. In his warning on
leaving the bank Mr Haldane pointed to a
rise in longterm financialmarket mea
sures of expectations for Britain. But at 0.3
percentage points above the past decade’s
average this is hardly the stuff of night
mares. As for everyday consumers, surveys
purporting to reveal their expectations in
the matter have found them to be increas
ing, but only modestly.
The phantom menace?
These “anchored” expectationsgive rich
world central banks some slack when it
comes to ignoring temporary price surges.
Changes in their attitude to inflation en
courage them to make full use of it. Since
August 2020 the Fed has been targeting an
average inflation rate of 2% over the whole
economic cycle. An overshoot now—the
Fed expects inflation to be 3.4% at the end
of the year—can make up for past or future
shortfalls. The ecb, which expects infla
tion to be 2.6% at the end of the year, is on
the cusp of making a change to its declared
goals which will make overshooting its tar
get more acceptable. (The unveiling of the
new regime will come shortly after The
Economistgoes to press on July 8th.) The
Bank of England also appears to have be
come more tolerant of the idea of inflation
overshoots.
The combination of anchored expecta
tions and changing attitudes explains why
central banks, and especially the Fed, seem
so far to be relatively relaxed about infla
tion, making it clear that they are cogni
sant of the risks but staying well short of
precipitous action. Thus in June the Fed
signalled that it might raise interest rates
twice in 2023, sooner than previously ex
pected; some of its ratesetters have floated
the possibility of doing so next year. Mone
tarypolicy makers are also lining up to say
they are ready to slow the Fed’s purchases
of assets this year (see Finance section).
It is possible that central banks are
pushing their luck. In the past, rapidly ris
ing inflation expectations have typically
been a sign that things have already gone
wrong, not a sign that they are about to.
“Neither bond markets nor economists
have a great track record at forecasting in
flation,” concludes a recent analysis by Jo
seph Gagnon and Madi Sarsenbayev of the
Peterson Institute for International Eco
nomics, a thinktank. The idea that expec
tations could become deanchored is “not
my biggest worry, but if it’s not on your
worry list, you’re not thinking clearly
about the issue,” Mr Furman said recently.
(A senior economic adviser in Barack Oba
ma’s White House, he says his biggest wor
ry remains a recession, because though its
likelihood is low its consequences would
be dire.) Oxford Economics, a consultancy,
sees a 1015% chance of the American econ
omy shifting into a “highinflation re
gime” of price rises persistently above 5%.
And only richworld central banks, on
the whole, have the luxury of securely an
chored inflation expectations. Emerging
markets, which are also suffering the ac
celeration of global commodity and goods
prices, must be more careful about letting
the genie out of the bottle. They must also
pay keen attention to American inflation.
As the Federal Reserve tightens monetary
policy, it puts downward pressure on
emerging markets’ currencies, making it
more expensive for them to import goods
and creating another source of local infla
tion. Emergingmarket currencies have
fallen by an average of 1.5% since the Fed’s
comparatively hawkish meeting in June.
This is at a time when emerging mar
kets’ economies are on the whole less
healthy than the rich world’s because of
their lower vaccination rates. The tradeoff
they face between helping growth and con
taining inflation will be painful. Yet
though some central banks are raising in
terest rates, the situation is not acute. Both
Russia and South Africa have recently
floated the idea of tightening their infla
tion targets (currently 4% and 36%, re
spectively). That would be absurd amid
rampant upward pressure on prices.
Inflation is always worth taking seri
ously, not least because the belief that cen
tral banks will do so acts as a check in and
of itself. If the Federal Reserve spends a few
years trying to hit its 2% inflation target
from modestly above it little harm is done.
But this inflation carries an extra message.
For most of the 2010s richworld policy
makers could not understand why infla
tion was so low, and feared that it was be
yond their power to raise it. It is possible
that, even now, the euro area and Japan
may remain stuck in a lowinflation trap.
America has demonstrated that a re
markable combination of fiscal and mone
tary stimulus can cause prices to accelerate
even when interest rates are stuck at rock
bottom. That knowledge may prove useful
to others and in times to come. The chal
lenge now is tomakesure that the price
paid for it in termsofspiralling prices does
not rise too high.n