Fed obsesses over inflationary psychology

A day after the Wall Street Journal and the New York Times went gaga over the prospect of stagflation , the Financial Times has stepped back and uncovered the real story .

It's written in a rather — no, make that highly — convoluted way, so let me lay out the bottom line right here: The Fed doesn't care about inflation.  It does care deeply about the perception of inflation.

The Fed will tolerate higher inflation only as long as it believes
this is not seeping into inflation expectations and fostering a
1970s-style inflationary psychology.

That is the real stagflation risk – not a few months of weak growth and relatively rapid price increases.

Fed governor Frederic Mishkin said in a recent speech: “The flexibility
to act pre-emptively against a financial disruption presumes that
inflation expectations are firmly anchored.”

And yet, statistical measurements of inflation expectations are, to keep the nautical metaphor going, adrift:

…the Cleveland Fed calculates that the inflation rate the market
expects to prevail over the next 10 years has risen sharply, from 2.3
per cent at the end of July last year to 3.2 per cent today.

a different approach, Macroeconomic Advisers estimates that the
inflation rate expected to prevail over a five-year period starting
five years from now has gone up from roughly 2.5 per cent last spring
to 2.96 per cent today.

Some survey-based measures of inflation
expectations have also edged up, although they remain much more ­stable
than market-based measures.

“Recent data on inflation expectations are not all that reassuring,” says Stephen Cecchetti, a professor at Brandeis university.

If these professors and econometricians are wringing their hands over 3 percent inflation, imagine what they'd do if they saw what inflation would be if it were calculated [scroll down] the way it was back in Jimmy Carter's time.