Monday, March 26, 2007

Is the Fed complacent?

In ec 10 over the next few weeks, we will be talking a lot about the role of inflation expectations. Over the past few weeks, Fed governors Rick Mishkin and Randy Kroszner have given talks about inflation dynamics. Both talked about inflation expectations and raised the issue of complacency on the part of the Fed:

Here is Mishkin:

if the monetary authorities were to become complacent and to think that they could get away with not reacting to shocks that, in their mistaken view, no longer have the potential to cause inflation to rise persistently, then inflation expectations would surely become unhinged again. In short, complacency that might arise from the current low inflation persistence might result in deja vu all over again and return us to an era like the Great Inflation.
Here is Kroszner:

The stability of inflation could lead to complacency. As long as inflation expectations are well anchored, actual inflation will have a natural tendency to revert to the anchor of long-run inflation expectations. Under such circumstances, policymakers may be tempted to relax their resolve in responding to potentially inflationary developments. Such relaxation could be costly, however. Inflation expectations have become well-anchored because the public has become confident that the Federal Reserve will do the right thing. But this belief will persist only as long as we on the Federal Open Market Committee continue to ratify the public’s expectations that inflation will remain low and stable. Thus, complacency would be a threat to the credibility that the Federal Reserve has worked so hard to acquire, and its loss would likely mean the reversal of many of the favorable inflation developments seen over the past two decades.
Why all this talk about complacency? Maybe, by talking about the risk of complacency, Rick and Randy are trying to tell people that they are not complacent in order to influence inflation expectations. Or maybe they are trying to persuade the other members of the FOMC to take a more hawkish stand against inflation.