Worrying about inflation. There isn't enough.

The econoblogosphere hasn't stopped second-guessing, since the Fed raised its rates a couple weeks ago. Here are three more examples, including one from the ultra-conservative Wall Street Journal .

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It’s Time to Make a Hard U-Turn
original article by Narayana Kocherlakota
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Market-based measures of long-term inflation compensation have fallen persistently and dramatically since mid-2014. This decline means that the Federal Open Market Committee (FOMC)  is confronting a significant risk to its credibility. It must act aggressively in the near-term to eliminate this risk. 

It is true that there are two possible explanations for this decline in market-based measures of long-term compensation. The first explanation is that should be viewed as a transitory phenomenon, due to some mysterious (to me) interaction between the market for inflation-protected TIPS bonds and declining oil prices. The second is that the decline means that market participants believe that the FOMC will be unable or unwilling to keep inflation as high as 2% on a sustainable basis.  This interpretation seems a lot less mysterious to me, since the FOMC continues to tighten policy in the adverse of severe disinflationary headwinds (associated in part with the decline in oil prices). 

There’s no easy way to tell these stories apart in the data.  But this challenge is irrelevant for policymakers.  The first story simply tells policymakers to ignore the decline in longer-term breakevens. Because the first story makes no specific policy recommendation, policymakers can simply ignore the possibility that it is true.  (Things would be different if, for example, the first story argued in favor of tighter monetary policy.)

In contrast, as long we put the slightest weight on the second story of declining credibility being true, it matters considerably for policy.  The FOMC’s tightening cycle is systematically lowering longer-term inflation expectations generally, and especially during future recessions.   The erosion of credibility means that real interest rates will be higher whenever the Fed is at the zero lower bound in the future - and that means lower employment and prices in those times.  (You can start to see the potential for a self-fulfilling trap that has so many so concerned.)

All central bankers agree that, without anchored inflation expectations, a central bank cannot be effective at achieving its price and employment objectives.   That’s why the main mission of a central bank is to keep inflation expectations well-anchored.  The evidence continues to mount that the FOMC is failing at this task. The Committee needs to confront this significant credibility threat by reversing its tightening cycle quickly and decisively. 

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Narayana Kocherlakota is a former Regional Fed President and FOMC member. Influential thinker. He is one of the very few who has openly said, "I was wrong about the need for austerity."

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Expecting less inflation
original article by Tyler Cowen, Marginal Revolution
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Here is  the associated WSJ article .  Yes oil is down and the Fed did a slight rate hike, but still the broader lesson is that we are moving into economic corridors we do not understand.  I don’t know that any theory has done a good job predicting inflation dynamics.  Wages are showing (finally) some very modest growth, so the “we were in a liquidity trap, deflation was delayed because wages are sticky, finally wage are falling” explanation also seems wrong.  I also don’t think we will be seeing another Fed rate hike anytime soon.  

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The Market Is Flashing an Inflation Warning Sign.
Should Anyone Care?
original article by Ben Eisen, Wall Street Journal
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Some think an arcane gauge of expectations is worrisome; others find it meaningless

Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis
PHOTO: BRIAN SNYDER/REUTERS

  The market is craving inflation. By one measure, it isn’t expected anytime soon.

After trending downward for more than a year, the inflation gauge known as the five-year, five-year forward inflation break-even rate on Tuesday was at its lowest point since 2009, according to data from the Federal Reserve Bank of St. Louis. The measure calculates the expected pace of price increases over the five-year period that begins five years from now.

A low level can indicate investors aren’t moving to guard against inflation, for example by purchasing inflation-protected securities.

Fed alum Narayana Kocherlakota last week referred to the low reading as a “worrisome signal,” a view he reiterated Wednesday as oil prices declined even further and the U.S. consumer-price index for December failed to meet economists’ expectations. On Tuesday, the gauge indicated annual inflation of 1.6% for its period.

“The kind of dramatic move we’ve seen is conveying information to us,” Mr. Kocherlakota said last week. Mr. Kocherlakota was president of the Federal Reserve Bank of Minneapolis until last month, and this month became a professor at the University of Rochester.

Although inflation can be painful when intense, to have some is a hallmark of healthy economic growth. The Fed currently targets annual inflation of 2%.

Not everyone buys into the worthiness of the five-year, five-year forward as a reliable measure of inflation expectations, however. Some question whether the measure, which is based on a mix of rates on Treasurys, signals a deteriorating economic outlook or simply reflects short-term market movements.

Last fall, Bespoke Investment Group, a research firm, studied a variety of market-based inflation expectations and found that together, they produced an outlook that varied widely enough that they couldn’t be considered accurate. The group concluded that the five-year, five-year forward is an arcane measure of risk appetite. In another report this past Thursday, the research firm said, that, looking back over the past 18 years, the indicators they studied had very little bearing on actual inflation.

To be sure, few if any of the market-based and survey-based measures that exist to forecast the likely path of inflation have predicted the 43 consecutive months that inflation has undershot the Fed’s target.

“There is a philosophical problem with taking a financial market price and saying that’s the expectation,” says George Pearkes, an analyst at Bespoke.

Michael Bauer and  Erin McCarthy , researchers at the Federal Reserve Bank of San Francisco, published a letter in September asserting that “financial markets can provide little additional useful forward-looking information about inflation” because other factors affect the market prices.

James Bullard , president of the St. Louis Fed, in the past has criticized market-based indicators of inflation views as unreliable.

Still, he said last Thursday that with oil prices sinking, he is becoming increasingly concerned that market-based indicators could become a self-fulfilling prophecy of low inflation; in other words, that the expectations themselves can drive what actually happens.

And Chicago Fed President Charles Evans last week called the drop in market-based inflation metrics “troubling.”

Mr. Kocherlakota last week said the gauge is flawed but insisted it is an important tool, especially as price increases have consistently stayed below the Fed’s annual target of 2%.

“The attitude toward a signal with noise is not to completely ignore the signal.”