Officials head into Fed meeting with uncertain long-term inflation outlook
Among the uncertainties facing Federal Reserve officials as they debate the proper setting of monetary policy, one of the trickiest has been divining where inflation is going, especially over the longer run.
Fed officials hold that expectations about where prices are heading exert a strong pull on current levels of inflation. More importantly, stable long-term expectations grant officials confidence that whatever challenges the economy faces, the public has faith inflation will be steady eventually.
The last few months have been tricky in that regard, notably in surveys of households.
President Donald Trump's global trade war is widely expected to push up inflation via surging import taxes. It's unclear whether that will be a one-time hit or something longer lasting. If it's the former, some Fed officials have signaled they could look through it, but the latter could call for interest rate policy to remain on the tighter side.
The Fed is expected to hold rates steady on Wednesday, but it is less clear after that just when the central bank might cut rates, as it penciled in last March.
When it comes to survey-based measures of the price-pressure outlook, the Federal Reserve Bank of New York and the University of Michigan questionnaires are the most closely watched. Both have shown shifts in near-term expectations, but for some time their longer-run readings have diverged. Market-based readings, meanwhile, have generally been more stable. Collectively it's led policymakers to question what's really going on.
'DRAMATIC INCREASES'
Fed Governor Christopher Waller said this month 'we are seeing a dramatic disparity' in the inflation expectations data, including that of professional forecasters.
Waller, citing the Michigan data, dismissed it. He noted that if households were truly expecting high inflation in the longer-run future they'd be pressing for much higher wages to compensate, and they aren't. He also said there'd also likely be a persistent surge in consumer spending to get ahead of higher prices, and while that appeared to have occurred briefly for some big-ticket purchases like automobiles earlier this spring, it has not been sustained.
'I prefer to look at market-based measures of inflation compensation and professional forecasters' expectations because they have money on the line,' Waller said, and noted as a result, 'my assumption (is) that longer-term inflation expectations remain anchored.'
Governor Adriana Kugler also said the Michigan data caught her attention, noting it showed 'the most dramatic increases' but also flagging methodology changes that have caused some to question its findings.
'While I take seriously the concern that recent methodological changes in the survey may have made this measure less reliable, this survey is a longstanding and important barometer of consumer sentiment, and I still monitor the signals it is giving us closely.'
NEW WAYS, SIMILAR ANSWERS
The University of Michigan's Surveys of Consumers have been asking households to estimate what inflation would be since the late 1970s. When its 5-year inflation estimate surged in early June 2022, it helped nudge the Fed toward an outsized 75-basis-point rate hike over the more modest action markets had been expecting.
Last year, the survey transitioned from phone-based interviews to web-based interviews. Many economists have wondered if that has affected its findings, especially since Michigan data on longer-term expectations has been notably higher than New York Fed data pointing to a steadier outlook.
Joanne Hsu, who directs the University of Michigan survey, dismissed the methodology shift as a non-issue. The organization ran parallel surveys — both phone and web — for seven years before formally changing and from this experience, she said, 'we know very well how inflation expectations operate via web interviewing versus phone interviewing, and they basically move in parallel.'
Hsu noted another key difference is the New York Fed uses panels of respondents who are involved for a year while her organization rotates participants. Hsu said engaging respondents repeatedly causes them to pay more attention to what they're being asked about, and in being better informed they're less likely to send a reliable signal about how the broader public views price pressures.
Hsu said better survey outcomes come from a mix of 'informed people, uninformed people, high-income people, low-income people, you know, people across the spectrum. And so that's what we're trying to do, we're trying to get all of those different types of people into our data' because that's the truest expression of expected inflation.
Hsu cautioned survey watchers from fixing on specific numbers and said, 'the trend is much, much more important than the level.'
'People are very worried about the inflation outlook right now,' she said, although those fears have abated somewhat amid Trump's retreat for now from some of the stiffest tariffs he had proposed earlier in the year.
(Reporting by Michael S. Derby; Editing by Andrea Ricci)
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