John Williams, Speech: A Steady Anchor in a Stormy Sea

“This analysis and related studies imply three criteria for well-anchored inflation expectations: “sensitivity,” “level,” and “uncertainty.” Let me take each in turn.”

“The sensitivity criterion states that although near- and medium-term inflation expectations may respond to economic shocks, expectations of inflation far in the future should not. Well-designed monetary policy will generally allow for some response to shocks of short- and medium-term inflation expectations in order to balance competing objectives, but long-run inflation expectations should not be affected.”

“In contrast, the level criterion applies the more stringent standard that the rate of long-run inflation expectations be consistent with the central bank’s long-run inflation target. In other words, it demands that expectations not just be anchored, but anchored to the right spot.”

“The third criterion—uncertainty—requires that uncertainty about future inflation increases less than linearly with the forecast horizon. Transitory responses of inflation to shocks imply uncertainty about future inflation, even far in the future. The uncertainty criterion is about the relationship between the magnitude of uncertainty and the forecast horizon.”

Conclusion:

“The importance of maintaining well-anchored inflation expectations is a bedrock principle of modern central banking, but its precise meaning and validation has been open to interpretation. My goal today has been to use economic theory to identify empirical criteria that can be used to assess the anchoring of inflation expectations during the ongoing episode of high inflation. The news is mostly good—longer-run inflation expectations in the United States have remained remarkably stable at levels broadly consistent with the FOMC’s longer-run goal. Inflation uncertainty has increased, but this does not appear to be due to unmoored longer-run expectations. The one surprising wrinkle worth further study is the increasing divergence in views about future inflation, including the high share of those expecting deflation, and what this portends for the future.”