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Happy Independence Day!
This edition was written by Alex Conner, Georgia Nabors, Lorae Stojanovic, and Louise Sheiner.
In 2020, the Fed adopted flexible average inflation targeting, aiming for 2% average inflation over time and aiming for above-target inflation following periods when inflation has been persistently below 2%. Using high-frequency bond market data, Luigi Bocola of Stanford and co-authors find that the relationship between expected future nominal interest rates and expected future inflation was positive and stable from 2000 to 2020. However, this relationship weakened from 2020 to 2022, suggesting that financial markets viewed the Fed to be less responsive to changes in current inflation following the 2020 revision of its monetary policy framework. The authors estimate that the implementation of average inflation targeting accounts for approximately half of post-pandemic inflation.
Nicola Gennaioli of Bocconi University and co-authors examine the sharp rise in consumer inflation expectations following the pandemic, particularly among the elderly. They find that people are more likely to recall recent inflation experiences, formative inflation experiences from their early adulthood, and inflation experiences most similar to the current inflation environment. The last factor drives the key de-anchoring behavior observed in the data: As people experience higher inflation, higher inflation episodes in their past become more salient, raising inflation expectations more quickly than only updating beliefs for current inflation would imply. The authors contend that this mechanism explains why the elderly increased their inflation expectations more than other groups – in general, they have experienced more high-inflation episodes than younger generations, which became salient post pandemic. The mechanism also explains the steady re-anchoring of inflation expectations in 2023 as inflation fell. The authors conclude, “Memory models… appear to be a promising way to study belief formation, including macroeconomic expectations. We view the current analysis as a first step toward developing a cognitively founded model of expectation formation applicable to macroeconomics and finance.”
Ling Cen of the Chinese University of Hong Kong and co-authors compare the financial performance of American firms with and without U.S. government customers during the U.S.-China trade war and Russia-Ukraine war. Counterintuitively, firms that count the U.S. government among their customers increase their imports by 33% following the onset of formal sanctions. These firms also grow more quickly, exhibit more profits, and have a higher survival rate than otherwise comparable peer firms without the U.S. government as a client. Closer analysis of individual firms which benefit from their relationship with the U.S. government – such as Honeywell, a multinational corporation focusing on aerospace, building technology, performance materials and technologies, and safety and productivity solutions – reveal that they are twice as able to obtain tariff exceptions, and more prone to hire ex-government officials. Connections to the government, the authors conclude, provide “a substantial strategic benefit... particularly at times of political tension, empirically dominating and more than offsetting (on average), any countervailing effects.”
The US ISM Manufacturing Purchasing Managers Index summarizes economic activity in the U.S. manufacturing sector.A value above 50 indicates an expansion and a value below 50 indicates shrinking of the manufacturing economy.
"Our pragmatic gradualism is consistent with a gradually higher weight given to the projected outlook – and giving gradually lower weight to the inflow of data. This reflects time-varying uncertainty and risks. Data are inherently noisy and there is a risk of overreacting to volatile news, especially until the end of this year: so 'data-driven' in the current inflation environment does not mean 'flash-driven'… As data surprises are now smaller and revisions to the current assessment more minor compared to two years ago, we are gaining more confidence in the forecast and more scope to disregard smaller bumps in the disinflation process," says François Villeroy de Galhau, Governor of the Banque de France.
"Let me conclude with a metaphor. The car racing at Le Mans this year was particularly challenging in treacherous weather conditions and 10 cars abandoned because of mechanical failures. This underscores that the more uncertain the journey, the more reliable the vehicle you need. This equally applies to monetary policy and central banks: in uncertain times, we need a reliable vehicle. We have solidity from our two pillars of independence and our price stability mandates. Be assured that, through the present uncertainties, the credibility of the Banque de France and the ECB, and the trust they inspire, will be firmly anchored on these two pillars."
The Hutchins Center on Fiscal and Monetary Policy invites you to attend the 13th annual Municipal Finance Conference on Wednesday, July 17 and Thursday, July 18. The event will be held both online and in person.
