The below was originally shared via the College of Central Bankers on June 17, 2021 in response to the Federal Open Market Committee meeting on June 15-16.

I would like to try to clarify some points of confusion I see arising from the commentary following last week’s FOMC meeting.  The dot-plots continue to be misunderstood. For example, many comments (including from the Chair) referenced the optimistic and transitory path of the inflation outlook found in the SEP and then downplayed the relevance of the dot-plot. But these projections of inflation are not unconditional. At least 13 participants thought the appropriate path of the funds rate involved between 1 and 3 interest hikes over the next 2 1/2 years. If those participants had been asked what their inflation forecast would be without those rate increases, it most likely would have been higher, thus inflation in the out years would be higher and thus appear less transitory than the SEP reported. We don’t know how much higher but surely we know the values would be higher than those reported.  So it can be very misleading to think about the projections without an appreciation or understanding of participants’ thoughts on appropriate policy.  Thus, the dot-plot is very useful, and actually necessary in many circumstances, in interpreting the projections. This point is very often missed in the media discussions and on occasion by members of the FOMC when discussing the SEPs.  Of course, the SEPs don’t tell us all that we would like to know, but interpreting them correctly can be informative. 

A related point is that the discussion of inflation almost exclusively talked about individual prices like lumber or used cars as if the path of inflation was some exogenous process. What seemed to be completely lacking was noting that inflation and its future path surely depend on the current and future path of monetary and fiscal policy, both of which are extraordinarily accommodative. Money growth is more expansionary than at any time since WWII and the Korean War and the same could be said of fiscal policy. How much of the current high inflation will be transitory versus more persistent will most likely be determined by policy choices, not the price of lumber.

Monthly PCE inflation has been above 2 percent in 10 of the last 12 months.  The price level moved above its Jan 2020 high in June 2020 and the one year inflation rate is 3.6 percent and the 2 year rate is 2 percent, above the 10 year pre-covid trend of 1.6 percent.  It would be nice if the Fed could fill us in on how they intend to apply their asymmetric make-up strategy going forward. I suspect we won’t hear much about that.  They are too busy struggling to reconcile (wordsmith) their inflation guidance with their guidance that they will not raise rates until maximum employment is reach. Discretion reigns. They created this problem, now they will figure out a way to muddle through without admitting a mistake.  We will see what happens to the economy.