Yesterday, the US Federal Reserve (the Fed) raised the official interest rate by 25 basis points and announced it would begin reducing its US$4.5 trillion balance sheet.
In her statement accompanying the announcement, Fed chair Janet Yellen indicated the bank would ignore a dip in inflation data, labelling it as “noisy”.
But for Standard Life Investments (SLI), the Fed’s predictions about underlying inflation pressures have been poor ever since the GFC, and constitute an “own goal”.
“The least forgivable of these [own goals] has arguably been the consistent tendency [of western central bankers] to overestimate the underlying inflation pressures in economies,” said SLI in an economic note.
The Fed overestimated underlying inflation in the US economy in 2013, 2014 and 2016, said SLI.
“Only at the start of 2015 when the oil shock was at its peak and the dollar had appreciated close to 20 per cent over the previous two years, did officials gauge the inflation outlook correctly,” said the note.
“The Fed has not been the only central bank to make these errors. The [Swedish] Riksbank, RBNZ, RBA, ECB and BoJ have also all had to downgrade overly ambitious inflation forecasts over recent years.”
Because of central bankers’ “misunderstanding of inflation”, monetary policy has been too tight and real interest rates too high since the GFC, said SLI.
“It has also undermined private agents’ faith in the ability and intent of central banks to meet their inflation objectives at all, with low inflation expectations becoming increasingly embedded in the pricing of government bonds and wage-setting decisions,” SLI said.
“With the risks to most central banks’ inflation forecasts still to the downside, they face important tests over the coming months; learn the lessons of the recent past and proceed even more slowly, or press on regardless and risk locking in low inflation for good.”
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