MNI INTERVIEW: Inflation Expectations Troubling-Gorodnichenko

U.S. inflation expectations are not well anchored despite official assurances to the contrary, elevating the risk that shocks like a trade war could lead to more persistent price pressures and perhaps even warrant interest rate hikes, Berkeley economist and San Francisco Fed adviser Yuriy Gorodnichenko told MNI. 

“Policymakers keep saying inflation expectations are anchored. Whether you look at survey evidence, especially for households and firms, it’s not clear at all that those expectations are very anchored,” he said in the latest episode of The FedSpeak Podcast. 

The post-Covid inflation experience has left consumers and businesses especially sensitive to price changes in a way that could quickly reignite inflation, which even before tariffs was still significantly above the Federal Reserve’s 2% target, said Gorodnichenko, who presented his research on the issue last month at the Fed Board's 2nd Thomas Laubach Conference. 

This sensitivity is evident from just how quickly the expectations of households and businesses have ratcheted higher on fears of higher prices from U.S. tariff policies, he said, pointing to the four percentage-point spike in one-year inflation views from the University of Michigan’s Survey of Consumers to 6.5%. “This all happened in a matter of a few months. That’s not consistent with anchored inflation expectations."  (See MNI INTERVIEW: Inflation Expectations Worrisome For Fed-Umich)

DON'T RULE OUT HIKES

While he sees risks of both slower economic growth and higher prices from tariffs, he thinks inflation could rise significantly in coming months. 

“I wouldn’t be surprised if inflation goes above 4%, this year,” said Gorodnichenko.  “If we look at the expectations of households and firms. This suggests to me that we may have an inflation problem regardless of what happens” with the trade war.

That would leave the Fed in an unenviable position if the economy is slowing, and might even force policymakers to put the idea of monetary tightening back on the table. 

“At a minimum they should not be doing cuts, they should maintain the current interest rate, and then, depending on circumstances, even raise interest rates to send a signal that they are serious about inflation and they don’t want to have another surge of inflation,” he said. (See MNI POLICY: Fed Cut Impetus Fades Alongisde Recession Fears)

LISTEN TO SURVEYS

Part of the problem for policymakers is identifying the right measure of inflation expectations. The FOMC consensus is that long-term inflation expectations are well-anchored, in part because financial market measures indicate as much. 

But Gorodnichenko warned that his research showed consumer and business surveys were better predictors of the post-covid inflation jump than professional forecasters. In addition, he noted that in the Great Inflation of the 1970s bond investors took a long time to internalize the idea that price pressures were not fleeting. 

“When you look at the inflation dynamic in the 1970s, you see that the bond market didn’t expect inflation to be very persistent in the mid-70s or even towards the end of the 70s,” he said.  “So it doesn’t mean that if professional forecasters don’t predict inflation we’re not going to have any inflation.”

The Fed’s Beige Book report this week noted “widespread reports of contacts expecting costs and prices to rise at a faster rate going forward."

Fed officials have outlined two broad scenarios regarding tariff-related price increases, one in which they are simply a one-time hit and a second where price pressures become more embedded. 

“It’s not a crazy proposition that we should look through one-time shocks,” said Gorodnichenko. “But if you have unanchored inflation expectations then this proposition is much less clear.”