The Federal Reserve needs to make sure that tight labor markets do not spark a sustained surge in inflation, but equally that inflation expectations do not get stuck too low, New York Federal Reserve Bank President John Williams said on Friday.
The concern about excessively low inflation is remarkable in the context of a U.S. unemployment rate of 4 percent, well below what most economists believe is sustainable in the long run. Traditionally, economists have found that when labor markets run hot, eventually inflation will as well.
That relationship may have changed, according to a spate of new research from within and outside of the Fed that some policymakers have used to justify the U.S. central bank’s new stance of “patience” on interest rates despite very low unemployment.
Williams made the remarks in response to a paper released on Friday that argued that though upward price pressures are currently muted, the Fed needs to guard against the possibility that low unemployment rates and rising wages could eventually spark higher inflation, as it did in the 1960s.
“I concur that we must remain vigilant regarding a sustained takeoff in inflation,” Williams said, citing his own analysis that showed low unemployment does in fact still exert upward pressure on prices.
But unlike the 1960s, he said, inflation dynamics have changed so that even if prices surge temporarily, that increase does not get embedded into inflation expectations, keeping inflation from rising sustainably above healthy levels.
Indeed, he said, inflation expectations are key to keeping inflation on track, and expectations are shaped in large part by experience. Inflation’s recent track record of riding well below the Fed’s 2 percent target is, therefore, concerning, he said.
“We must be equally vigilant that inflation expectations do not get anchored at too low a level,” he said. “This persistent undershoot of the Feds target risks undermining the 2 percent inflation anchor.