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April 17, 2013

Fed Watch: Bullard Concerned About Low Inflation

Tim Duy:
Bullard Concerned About Low Inflation, by Tim Duy: St. Louis Federal Reserve President James Bullard sees inflation as a potential problem, but not in the way you might think. From the Wall Street Journal:
Federal Reserve Bank of St. Louis President James Bullard said Wednesday inflationary pressures may be growing too weakly and if they soften further, the central bank may have to boost its asset buying to bring price pressures back up to more desirable levels.
“Inflation is running very low” as measured by the personal consumption expenditures price index, the Fed’s favored inflation gauge, the policymaker said. “I’m getting concerned about that,” he said.
“If inflation [gains] continues to go down, I’d be willing to increase the pace of purchases” of bonds the Fed is now engaged in, Mr. Bullard said. “This is not what I expected, and I think inflation should be closer to the target than it is,” the official said, adding he considers it just as important to defend the Fed’s 2% inflation target from the low side, as it is to keep prices from going over 2%.
This is the problem:
0213PCE
With the Fed's preferred inflation target trending down, it seems a little silly to start talking about ending the asset purchase program. Indeed, as Bullard suggests, there might be room to expand it further. Note also that Bullard comes to this conclusion despite his concern that monetary policy has limited ability to create jobs, the main point of his speech. See the Wall Street Journal article cited above or Neil Irwin for more.
While everyone is busy watching the labor market for signs that the Fed can wind down asset purchases, we tend to forget that inflation should be part of the equation as well. From the most recent FOMC statement:
The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.
The phrase "in the context of price stability" should cut both ways. The Fed might need to tighten policy even if the labor market is not improving if inflationary pressures start to emerge. But at the same time, it should also mean that the Fed may need to increase the pace of asset purchases even if the labor market is improving. That seems to be the current situation, yet we hear alot of Fedspeak suggesting a widespread inclination to end asset purchases this year regarless of the recent bout of disinflation.
That said, inflation might be set to tick up in the months ahead. From MIT's Billion Prices Project:
0418MIT
Not a worrisome move, but enough to suggest that Bullard's low inflation concern might be short-lived.
Bottom Line: Bullard reminds us the exit from the asset purchase program should not be simply a function of labor markets, but also a function of inflation. And the current path of inflation does not indicate that policymakers should be rushing ahead with a plan to end QE this year.

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