Evans worried about inflation expectations

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While he doesn’t “see much risk of an outsized breakout in inflation,” Federal Reserve Bank of Chicago President Charles Evans said Monday he is concerned that inflation expectations are too low.

“The fundamentals for economic growth in the U.S. are sound, and we are close to our full employment goal,” Evans told the Economic Club of Grand Rapids, Mich., according to prepared text released by the Fed. “But inflation has been lower than the FOMC’s 2 percent target for too long, and there is little in the recent data to suggest that inflation will soon rise to target. So I believe maintaining policy accommodation until we are more demonstrably on a sustainable path to 2 percent is key for reaching that objective — and for maintaining the credibility of our price stability goal.”

As such, he said, he backs “a gradual and cautious approach” to removing monetary policy accommodation, as well as the Federal Open Market Committee’s announcement last week that it will begin to reduce its balance sheet. “The planned path of reductions is very shallow and has been well communicated to markets,” he said. “Accordingly, it should generate only a modest change in financial conditions.”

Evans said, “I don’t see much risk of an outsized breakout in inflation.”

“I am more concerned about our ability to get inflation back up to target within a reasonable period,” noting “the natural rate is difficult to measure and changes over time.” As a result, there could be more slack in the labor market than believed, he said.

“I am concerned that inflation expectations — the third element in the standard inflation model — may be too low. Expectations of future inflation play an important role in the inflation process,” he said. “I am concerned that inflation expectations are too low today, making it harder to achieve our 2 percent target.”

The economy has progressed and fundamentals remain sound, Evans said, although Hurricanes Harvey, Irma, and Maria complicate the outlook for the remainder of this year. “It is too early to assess the impact of these terrible events on the national economy. Based on past experiences with natural disasters, we should expect lower national output growth in the third quarter.”

Estimates of the impact range from 0.50% to 3%, most center around 1%.

By next year there should be a “boost to growth as economic activity recovers and rebuilding efforts get under way.”

Evans reiterated that progress toward the price stability mandate “has been unsatisfactory,” being below target “almost continuously since 2008.” Despite improvement late last year into this year, inflation cooled and was at a 1.4% annual pace in July.

Saying he expects inflation to return to 2% “over the medium term,” Evans said he is not as optimistic as the median forecast in the Summary of Economic Projections, which sees inflation at 2% by 2019. “However, given the recent data and a nine-year track record of low inflation, it’s reasonable to ask why we expect inflation to get back to 2 percent,” he said.

But, he noted, before any more rate hikes, the Fed should look for "clear signs of building wage and price pressures. ... We should avoid taking policy steps that could be misread as a lack of concern over the inflation outlook. In my view, that would be a policy misstep that would further delay achieving our inflation objective."

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Monetary policy Charles Evans Federal Reserve FOMC