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In the prevailing theory of inflation among Federal Reserve officials, inflation expectations matter a great deal. They believe that inflation expectations powerfully influence both where inflation is now and where it is going. If inflation expectations are "well-anchored" at the correct level, inflation will stay around that level. If they become unanchored, we might have a problem.
The problem, of course, is no one quite knows how to measure inflation expectations. You can try to suss them out by looking at bond prices, particularly by comparing the differences in yields between inflation-protected bonds and regular bonds, the so-called breakeven rate. That might tell you what bond investors think of inflation, but it is far from clear that it is the bond investor expectations that matter when it comes to influencing future prices.
Another method is by taking surveys. Surveys of consumers from Gallup, the University of Michigan, and the Conference Board all ask about expected infation. One of the newer entrants, from the Federal Reserve Bank of New York, has been attempting to gauge inflation expectations since 2013. On Monday, the New York Fed released the finding for August, and inflation expectations both for this year and three years from now hit record highs.
Food prices are seen rising by 7.9 percent over the next 12-months. Rent is expected to increase 10 percent. Medical care costs are anticipated to rise 9.7 percent. The general price level is expected to rise 5.2 percent, up from 4.9 percent a month ago.
This puts the Fed in a bind. The economy is weakening, according to many data points. Job creation was much lower than expected last month, and consumer confidence has deteriorated sharply. That weighs on the side of keeping monetary policy extremely accommodative. But the news that inflation expectations have raised anchor and set sail pushes the other way.
Most likely, this will not get resolved at the Fed's September meeting. Instead, the Fed will wait to see which way things break: more sluggishness or more inflation? There's no meeting in October, so that pushes any big decision off until November.
One thing no one knows is what Jay Powell and company will do if the economy continues to slow but inflation keeps getting worse.
– Alex Marlow & John Carney
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