Janet L. Yellen
Inflation Dynamics and Monetary Policy
September 24, 2015
You see original and all speech from this link. Keeping
inflation stable at a moderately low level is important in 1980’s and 1990’s.
Nowadays , this idea is changed because USA needs more and more inflation (same
as after the great recession 1930’s)
Firstly,
I need to indicate, FED works on (PCE) personal consumption expenditures. This
is the measure of inflation in USA.
Please be careful, it is not PCI. FED concentrates core inflation which
excludes food and energy prices.
Yellen speaks now. Firstly, we need to
take lesson of inflation history.
Today many economists believe that these features of
inflation in the late 1960s and 1970s--its high level and lack of a stable
anchor--reflected a combination of factors, including chronically overheated
labor and product markets, the effects of the energy and food price shocks, and
the emergence of an “inflationary psychology” whereby a rise in actual
inflation led people to revise up their expectations for future inflation.
Together, these various factors caused inflation--actual and expected--to
ratchet higher over time.
Yellen
more concrete indicated that low inflation may be a indicator of bad economic
situation.
United States has experienced very low inflation on
average since the financial crisis, in part reflecting persistent economic
weakness that has proven difficult to fully counter with monetary policy.
Why
does FED use core inflation ?
Food and energy prices can be extremely volatile, with
fluctuations that often depend on factors that are beyond the influence of
monetary policy, such as technological or political developments (in the case
of energy prices) or weather or disease (in the case of food prices). As a
result, core inflation usually provides a better indicator than total inflation
of where total inflation is headed in the medium term. As a result, core
inflation usually provides a better indicator than total inflation of where
total inflation is headed in the medium term. Of course, food and energy
account for a significant portion of household budgets, so the Federal
Reserve’s inflation objective is defined in terms of the overall change in
consumer prices.
What
are reasons for core inflation tends to fluctuate around a longer-term trend ?
Such deviations of inflation from trend depend partly
on the intensity of resource utilization in the economy—as approximated, for
example, by the gap between the actual unemployment rate and its so-called
natural rate, or by the shortfall of actual gross domestic product (GDP) from
potential output. This relationship--which likely reflects, among other things,
a tendency for firms’ costs to rise as utilization rates increase--represents
an important channel through which monetary policy influences inflation over
the medium term, although in practice the influence is modest and gradual.
Movements in certain types of input costs,
particularly changes in the price of imported goods, also can cause core
inflation to deviate noticeably from its trend, sometimes by a marked amount
from year to year.
Finally, a nontrivial fraction of the
quarter-to-quarter, and even the year-to-year, variability of inflation is
attributable to idiosyncratic and often unpredictable shocks.
What
determines inflation’s longer-term trend?
Theory suggests that inflation expectations—which presumably
are linked to the central bank’s inflation goal--should play an important role in
actual price setting. Most theoretical versions of the Phillips curve suggest
that inflation should depend on short-run inflation expectations, but, as an
empirical matter, measures of long-run expectations appear to explain the data better.
Estimated trend in inflation is in fact related to households’ and firms’ long-run
inflation expectations.
Yellen’s
analysis suggests that economic slack, changes in imported goods prices, and
idiosyncratic shocks all cause core inflation to deviate from a longer term trend
that is ultimately determined by long-run inflation expectations. Yellen’s
model of core inflation is a variant of
a theoretical model that is commonly referred to as an expectations-augmented
Phillips curve.
Is
there difference between Neo-Clasics and Neo Keynesian on inflation ?
See Tobin (1972) and Friedman (1968) for early
discussions of the theory underpinning the expectations augmented Phillips
curve. Theoretical descriptions of the inflation process remain an active area
of research in economics. In recent years, many economic theorists have used a
so-called new-Keynesian framework--in which optimizing agents are assumed to
face constraints on price or wage setting in the form of adjustment costs or
explicit nominal contracts--to model inflation dynamics. Although these
new-Keynesian inflation models can differ importantly in their specifics, they
all tend to assign a central role to inflation expectations and resource utilization
as drivers of inflation dynamics.
Why
anchored expectations are important ?
Situation shown in panel A, in which households’ and
firms’ expectations of inflation are not solidly anchored, but instead adjust
in response to the rates of inflation that are actually observed. Such
conditions--which arguably prevailed in the United States from the 1970s to the
mid-1990s--could plausibly arise if the central bank has, in the past, allowed
significant and persistent movements in inflation to occur. In this case, the temporary
rise in the rate of change of import prices results in a permanent increase in inflation.
This shift occurs because the initial increase in inflation generated by a
period of rising import prices leads households and firms to revise up their
expectations of future inflation. A permanent rise in inflation would also
result from a sustained rise in the level of oil prices or a temporary increase
in resource utilization.
Inflation expectations are instead well anchored,
perhaps because the central bank has been successful over time in keeping
inflation near some specified target and has made it clear to the public that it
intends to continue to do so. Then the response of inflation to a temporary
increase in the rate of change of import prices or any other transitory shock
will resemble the pattern shown in panel B. In this case, inflation will
deviate from its longer-term level only as long as import prices are rising.
But once they level out, inflation will fall back to its previous trend in the
absence of other disturbances. A key implication of
these two examples is that the presence of well-anchored inflation expectations
greatly enhances a central bank’s ability to pursue both of its objectives--namely,
price stability and full employment. Because temporary shifts in the rate of
change of import prices or other transitory shocks have no permanent influence
on expectations, they have only a transitory effect on inflation.
How
can we see inflation expectations ?
11-For
households, median long-term expectations from the University of Michigan
Surveys of Consumers; for professional forecasters, expectations derived from survey conducted by Richard Hoey and from the
Survey of Professional Forecasters, conducted by the Federal Reserve Bank of
Philadelphia.
2-Difference between yields on nominal
Treasury securities and inflation indexed ones, called TIPS.
What
do you think Phillips-curve approach to forecasting inflation?
The Phillips-curve approach to forecasting inflation
has a long history in economics, and it has usefully informed monetary policy
decisionmaking around the globe. But the theoretical underpinnings of the model
are still a subject of controversy among economists. Moreover, inflation sometimes
moves in ways that empirical versions of the model.
Yellen’s
last words:
However, we have not yet fully attained our objectives
under the dual mandate: Some slack remains in labor markets, and the effects of
this slack and the influence of lower energy prices and past dollar appreciation
have been significant factors keeping inflation below our goal. But I expect
that inflation will return to 2 percent over the next few years as the
temporary factors that are currently weighing on inflation wane, provided that
economic growth continues to be strong enough to complete the return to maximum
employment and long-run inflation expectations remain well anchored.
Dr. Engin YILMAZ
14.10.2017
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