Fed’s Yellen, Japan, and the Highly Imperfect World of ‘Expected’ Inflation

20-Mar (Wall Street Journal) — Federal Reserve Chairwoman Janet Yellen on Wednesday offered a peek into just how uncertain policy makers are about the future path of U.S. inflation—despite their hopes that it will gradually return to the central bank’s 2% target after several years of falling short.

She did so during her news conference in response to a question about the importance of inflation expectations to the Fed’s thinking about interest-rate policy. Policy makers see expectations as a window into future inflation, because they believe they can be self-fulfilling—that businesses set prices and workers bargain for wages based on their expectations of where prices will be in the future. Yet Fed officials acknowledge problems with the theory and in the way both consumer and market measures are derived.
Ms. Yellen cited the experience in Japan’s experience, where she said inflation expectations kept moving higher and yet never gave way to stronger price growth.

“The fact that survey measures are stable, even if they are stable at levels consistent with inflation objectives that the central bank wants to achieve, that’s not a guarantee that inflation will over time move to be consistent with those expectations,” she said. “An example is Japan, I would give you, where for many years the households and businesses expected positive inflation but there was a consistent undershoot.”

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PG View: I’m afraid we are Japan . . .