Krugman vs Cecchetti on Inflation
Two days ago, economist Steve Cecchetti offered a different take on the situation:
Over the last few weeks monetary officials have sounded increasingly worried about rising prices. On Wednesday, Richard Fisher, the president of the Federal Reserve Bank of Dallas, declared that inflation ''is running at a rate that is just too corrosive to be accepted by a virtuous central banker.'' I'm worried too -- but not about recent price increases. What worries me, instead, is the Fed's overreaction to those increases....
Much of the recent rise in core inflation probably represents the delayed effect of the big run-up in fuel prices a few months ago. And unless something else happens to drive up oil prices -- like, to give a wild example, a military strike on Iran -- inflation will probably subside in the months ahead.
For those who don't know him, I should note that Steve is a professor at Brandeis and author of a leading textbook on money and banking; he was previously Director of Research at the Federal Reserve Bank of New York. This does not mean that he is right about the inflation outlook, but it does mean that his view is worth taking seriously.
This morning's CPI report confirms many people's worst fears. Inflation is up. The all items CPI rose 5.5% at an annual rate for the month of May, and is up 4.2% since May 2005. This is well above recent (or acceptable) trends. Core measures faired little better, with the CPI excluding food and energy up 3.6% (a.r.) in May, and 2.4% over the past 12 months. The Median CPI computed by the Federal Reserve Bank of Cleveland increased 4.3% (a.r.) for the month, and is up 2.7% for the year. Importantly, the trends in all of these numbers are up. This time around, the detail of the report is worse than the headline numbers....
The implications for monetary policy are pretty clear. With inflation at 3%, one percentage point above the 2% implicit target of the FOMC, we can now expect the federal funds rate to rise to at least 6%. But the risk is that it will not stop there. I could easily see the inflation trend rising to 3.5% over the next 6 months, and then the federal funds rate will have to go much higher.
Update: Read more in my next post on forecasting inflation.