Saturday, March 16, 2013

Anchoring and inflation genies

Do not worry about inflation. Why?  Because expectations are "well anchored" and the "inflation genie" is not out of the bottle. That is today but what about tomorrow? 

The current inflation rates do not look like there is a problem at 2%, but if you look at financial assets like equities and housing there is a different story. This issue reaches back to discussions from 10 and 20 years ago. Should inflation measures include financial assets. Should the Fed focus on financial assets as part of their overall inflation targeting? 

The Fed clearly focuses on financial assets as a measure of their success with monetary policy. See, we are raising the value of financial assets and thus wealth so this will help the economy; nevertheless, you also have to look at the opposite side and ask whether there can be too much increase in prices of financial assets. Can temporary wealth increases be a bad thing? 

Anchoring of inflation expectations is very strange. It is like trust. It is hard to gain, but easy to lose. We have seen that with Fed creditability in the 1980's. So how much stock should be place in anchoring today and what will it get to change? There does not seem to be enough focus on how this anchor will be dragged to a new level. 

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