Americans have no clue what’s next on inflation

The Federal Reserve’s stated mandate is to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.” The first part is obviously a disaster right now, with more than 36 million Americans filing initial jobless claims in the past eight weeks, bringing US unemployment to levels not seen since the Great Depression. The last objective is easily met, with benchmark Treasury yields hovering close to all-time lows.
But what about stable prices?
For years, Fed officials fretted that consumers’ inflation outlook was almost too stable at historically low levels. Vice Chair Richard Clarida, for one, follows University of Michigan data that surveys expected price changes during the next five to 10 years. That gauge fell to 2.2% in December, a record low. A year earlier, when it was at 2.6%, he called it “within — but I believe at the lower end of — the range consistent with price stability.” Since 2012, expectations have fluctuated in a tight window of 2.2% to 3%, including 2.6% in a report. The central bank generally views 2% as its target rate.
The coronavirus pandemic has shaken American households to their core in any number of ways. At best, it’s acclimating to working from home and adjusting day-to-day behaviour. At worst, the most economically vulnerable individuals are suddenly unemployed and unsure when — or if — they’ll be rehired.
Fed Chair Jerome Powell previewed some of the devastation earlier this month from what was at the time an unreleased report. “Among people who were working in February, almost 40% of those in households making less than $40,000 a year had lost a job in March,” he said in prepared remarks. “This reversal of economic fortune has caused a level of pain that is hard to capture in words, as lives are upended amid great uncertainty about the future.”
Though seemingly insignificant for now, the once-stable outlook for inflation appears to also have shifted drastically. As America comes out from under the Great Lockdown, how central bank officials handle what could be early signs of unanchored inflation expectations, and how the public responds, could play a crucial role in any recovery.
In a blog post, New York Fed researchers found “unprecedented increases in individual uncertainty — and disagreement across respondents — about future inflation outcomes.” The share of people who expect deflation in 2021 increased from from less than 10% at the end of February to more than 20% a month later. Meanwhile, those who expect short-term inflation to be higher than 4% jumped from about 30% to almost 45% in the same period. In other words, although the median expectation might only show a small move, some households are bracing for a drastic swing.
At a high level, these are two vastly different economic scenarios. Deflation frightens policy makers because rational consumers would postpone purchases to get goods and services at a cheaper price. That would curtail economic activity and potentially exacerbate the situation.

—Bloomberg