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This edition was written by Sam Boocker, Alex Conner, Georgia Nabors, and Louise Sheiner.
What contributes to a successful disinflation? Using historical data on inflation, interest rates, and inflation expectations since WWII, Christina and David Romer of the University of California, Berkeley argue that the most important factor in successfully reducing inflation is the Federal Reserve’s ex-ante commitment to disinflation. The authors find that when commitment is low, disinflation efforts are small and short-lived, not because inflation expectations increase but because the Fed prematurely abandons contractionary policy. In contrast, when commitment is high, the Fed is willing to allow greater output losses to get inflation down. The Romers argue that the Fed’s strong commitment to disinflation has played an important role in reducing post-pandemic inflation and that, for this reason, their current disinflation effort will be successful.
Gabriel Chodorow-Reich of Harvard, Owen Zidar of Princeton, and Eric Zwick of the University of Chicago find that the 2017 Tax Cuts and Jobs Act (TCJA) increased business investment and sharply reduced corporate tax revenue but had smaller macroeconomic effects than proponents had predicted. The authors argue that the TCJA raised tangible corporate investment by 8% to 14%, which accounts for almost all the investment boost caused by the act. Provisions that directly encourage capital formation—like accelerated depreciation—deliver more investment per dollar of lost tax revenue than the change in the tax rate. Higher investment did not outweigh the effects of rate cuts on corporate tax receipts, which fell by 40%. The authors estimate that the act raised long-run GDP by less than 1% and labor income by about $750 per employee. They conclude that “extending all or most of the provisions in the Tax Cuts and Jobs Act and letting the rate cut remain will be costly relative to the growth effects these tax cuts buy.”
Using data from 1994 to 2023, Steven Sharpe and Antonio Gil de Rubio Cruz of the Federal Reserve Board find that a simple macroeconomic model of aggregate S&P 500 earnings, along with GDP forecasts and dollar exchange rate changes, can predict large and statistically significant errors in Wall Street analysts’ forecasts for corporate earnings. Specifically, the difference between the macro model forecasts and aggregated analyst forecasts predicts 50% of the analysts’ current quarter forecast errors and roughly 40% of quarter-ahead forecast errors. Analyst forecast errors predicted by the macro model in turn have predictive power for three-month stock returns. Moreover, the analyst forecasts are uncorrelated with the macro model forecasts, indicating that analysts do not fully account for available macroeconomic information.
Q: “So how has your confidence in the ability to get inflation on that path back to 2% changed this year?”
A: “Well, it has been a bit of a journey, right? Because we saw those very low readings in the last six months of last year, which I felt at the time and many observers did, was probably giving an overly optimistic read of the disinflationary underlying disinflationary trend," says John Williams, president of the Federal Reserve Bank of New York.
"Then we got those pretty high readings early in the year, which some of that seemed to be also unusual, not representing a trend. I feel like the past three months—and I would include in June, based on what we’ve seen—seems to be getting us closer to a disinflationary trend that we’re looking for. In terms of the confidence, I think these are positive signs. I would like to see more data to gain further confidence inflation is moving sustainably towards our 2% goal. We’ve got a few good months now. We had some months that weren’t good on inflation. So I definitely want to see the data continue to show signs that we’re moving sustainably to 2% to have greater confidence in that."
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