Sunday , April 18 2021
Home / S. Sumner: Money Illusion / AIT is increasingly credible

AIT is increasingly credible

Summary:
The Fed recently forecast 2.4% PCE inflation for 2021. The TIPS markets are showing evidence that investors expect 2% PCE inflation over 30 years, and somewhat higher inflation over the next 5 years. This is all consistent with the Fed’s 2% AIT framework, as some make-up is required for the 2020 undershoot of 2% inflation. Mostly because of AIT, the economic recovery will likely be much faster than during 2009-19.Note that TIPS are indexed to the CPI, which runs at least 25 basis points above the PCE that is being targeted at 2%. So TIPS spreads need to be adjusted downwards by at least 25 basis points to get a crude estimate of market PCE inflation forecasts. And finally, TIPS spreads are not a perfect indicator, as there may be a time-varying liquidity premium:

Topics:
Scott Sumner considers the following as important:

This could be interesting, too:

Tyler Cowen writes Saturday assorted links

Tyler Cowen writes So what’s it like being red-pilled by the median voter theorem?

Tyler Cowen writes Friday assorted links

Tyler Cowen writes Mexican drug cartel now assassinates its enemies using drones?

The Fed recently forecast 2.4% PCE inflation for 2021. The TIPS markets are showing evidence that investors expect 2% PCE inflation over 30 years, and somewhat higher inflation over the next 5 years. This is all consistent with the Fed’s 2% AIT framework, as some make-up is required for the 2020 undershoot of 2% inflation. Mostly because of AIT, the economic recovery will likely be much faster than during 2009-19.

Note that TIPS are indexed to the CPI, which runs at least 25 basis points above the PCE that is being targeted at 2%. So TIPS spreads need to be adjusted downwards by at least 25 basis points to get a crude estimate of market PCE inflation forecasts. And finally, TIPS spreads are not a perfect indicator, as there may be a time-varying liquidity premium:

AIT is increasingly credible

Tags:

 
 
 
Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

Leave a Reply

Your email address will not be published. Required fields are marked *