Loretta Mester, Speech: Comments on “Managing Disinflation”,

Recession

“But even within the forum paper itself there is a tension between the estimated Phillips curve findings and the historical analysis presented in Section 2. The historical analysis documents that the vast majority of disinflations in the U.S. and in other advanced economies have been accompanied by recessions, a finding that differs from the estimated Phillips curve results. Perhaps there is one way to reconcile at least part of the tension. It could be that when labor markets are overheating and inflation is high, policymakers tighten monetary policy to bring labor demand into better balance with supply to alleviate inflation pressures without intending to push the economy beyond that and into recession. Because this is a difficult calibration exercise, policy tends to overshoot and the economy does end up in recession in most disinflations. The implication is that policymakers need to be attentive to the lagged effects of policy actions as they bring inflation down.”

Inflation Expectations

“Anchored inflation expectations are highly desirable; they mean that the public finds the longer-run inflation target credible and that fluctuations in inflation will eventually die out. But during a period of very high inflation, the stability of inflation expectations cannot be taken for granted: the real world does not always cooperate with our modeling assumptions.”

“Over the past two years, short-term inflation expectations moved up with gasoline and food prices, which tend to have an outsized effect on households’ inflation expectations. As energy prices have fallen in recent months, short-term inflation expectations have eased, although they remain well above their prepandemic levels. This also raises the possibility that if energy and food prices rise again, short-run inflation expectations could also rise again. Most measures of medium- and longer-term expectations are also somewhat above their pre-pandemic levels, but they appear to be reasonably well anchored at levels consistent with our 2 percent target.”

“If inflation expectations were to become unanchored, their influence would offset the effect of any beneficial change in the resource gap. Monetary policy would then have to act more forcefully, and the return to price stability would be more painful and costly.”

Fed Funds

“Putting these pieces together for the current economic environment, while it is welcome news to see some moderation in inflation readings since last summer, the level of inflation matters and it is still too high. Policy decisions need to consider the risk around the forecast but also the costs of continued high inflation to households, businesses, and the longer-run health of the economy. The forum paper’s projections and recent research from the Cleveland Fed suggest that inflation could be more persistent than currently anticipated by many forecasters.17 I see the risks to the inflation forecast as tilted to the upside and the costs of continued high inflation as being significant. So in my view, at this point with the labor market still strong, the costs of undershooting on policy or prematurely loosening policy still outweigh the costs of overshooting. But policy also needs to be forward looking, and as inflation comes down, I anticipate that the balance of risks will shift.”