Tuesday, August 16, 2016

Jackson Hole preview: Fun with statistics

As we await the Fed`s annual Jackson Hole symposium on August 25-27, Bloomberg highlighted a research paper by Fed economist Jeremy Nalewaik. Nalewaik found that inflation and inflationary expectations had tracked each other well but started to diverge in the mid 1990's.

This paper is important to the future of Fed policy, as it pushes the Fed towards a lower for longer view where inflationary potential is far lower than previously expected:
“Movements in inflation expectations now appear inconsequential since they no longer have any predictive content for subsequent inflation realizations,” Nalewaik wrote.

He cites as a potential explanation for this a hypothesis offered in a 2000 paper co-authored by Yellen’s husband, Nobel prize-winner George Akerlof, who wrote that “when inflation is low, it may be at most a marginal factor in wage and price decisions, and decision-makers may ignore it entirely.”

Akerlof’s and Nalewaik’s research jibe nicely with ideas that St. Louis Fed President James Bullard has injected into the debate on the rate-setting Federal Open Market Committee this year.
If this paper becomes a major focus at the Jackson Hole meeting, then the Fed is likely to tilt towards a take-it-slow view on raising interest rates. However, I would argue that this analytical framework is highly sensitive to how the Fed picks its input variables. One wrong move could result in a policy error of major proportions.

The full post can be found at our new site here.

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