The forecasts attached to the Fed’s Jan minutes are a little strange. They show a slight increase in the central forecast for unemployment in 2010, and a slight decrease for 2012, but a marked increase in confidence that deflation has been averted.
This is a surprise, as higher unemployment now typically means a lower inflation forecast later.
The higher unemployment and core PCE forecasts leave the first 18m unchanged, and the combination of higher PCE inflation and lower unemployment lift the last 18m.
However, the rule remains negative for the entire forecast period.
The optimal rate troughed at -6.4% in Q4’09, and rises to -33bps in Q4’12.
The board has not yet decided which it’ll be – inflation as the excess reserve bomb explodes, or deflation, due to high excess capacity and sluggish growth. I think that the Fed is preparing so that they are able to lift rates if they need to – but I don’t think they’ll be ready until this issue clarifies.
Participants agreed that underlying inflation currently was subdued and was likely to remain so for some time. Some noted the risk that, with output well below potential over the next couple of years, inflation could edge further below the rates they judged most consistent with the Federal Reserve’s dual mandate for maximum employment and price stability; others, focusing on risks to inflation expectations and the challenge of removing monetary accommodation in a timely manner, saw inflation risks as tilted toward the upside, especially in the medium term.