Fed Officials Ask How to Better Understand Inflation After Surprises

Given those mistakes, policymakers have begun to suggest that the central bank needs to reassess how it looks at inflation.

“Our models seem ill equipped to handle a fundamentally different source of inflation,” Neel Kashkari, president of the Minneapolis Fed, said in an essay this week.

The Fed has historically seen lasting inflation as a product of two forces: An overly-tight labor market that is pushing up wages, and consumer and business expectations for higher prices, which can turn into a self-fulfilling prophesy by making it easier for firms to charge more.

But today’s inflation has been driven by pandemic-inspired shifts in demand that collided with constrained supply chains and Russia’s war in Ukraine. While shocks like that are typically expected to fade, they have had staying power this time, and were compounded first as rents rose rapidly and more recently as other service prices have taken off.

“We don’t understand inflation,” David Romer, an economist at the University of California, Berkeley, said on the panel with Ms. Cook.

For now, Fed officials are betting that rapid inflation will slow as supply chains untangle and as a housing cost spike that started in 2021 begins to moderate. But officials worry that while inflation was not originally caused by today’s rapid wage growth, it could be propped up by it — and the hot labor market is only now showing signs of slowing down.

“The pandemic has had a much more prolonged effect on labor supply than many expected,” Ms. Cook said on Friday. “Rapid nominal wage growth has accompanied the recent rise in inflation in ways that traditional measures of labor market tightness — such as the unemployment rate gap — might not be capturing.”

Article source: https://www.nytimes.com/2023/01/06/business/economy/fed-officials-ask-how-to-better-understand-inflation-after-surprises.html