Fed Credibility Hurt By Desire To Tighten In Face Of Falling Inflation Expectations

The Federal Reserve finishes up their June meeting today which will be followed by the scheduled press conference by Chair Janet Yellen. The ever-prescient Tim Duy raises an important question about how she will characterize inflation expectations going forward.  In prior statements, Yellen and the committee keep on insisting that they expect inflation to continue to climb to their stated goal of 2%. And yet, as even Yellen noted, inflation expectations have actually fallen putting the 2% goal seriously into question.  And, as Duy notes, interest rate tightening is usually predicated on rising inflation expectations, as this graph shows in the late 1990s and mid 2000s.

And yet the Fed keeps on signaling that it is intent on raising rates, sooner rather than later, even in the face of falling future inflation. After all, it is hard to reconcile the need for tightening while at the same time admitting that inflation expectations are actually falling. In fact, falling inflation expectations are actually a signal for further easing but there is no sign of that coming anytime soon from the Fed. If they continue down this road of pushing to raise rates in the face of falling inflation expectations, they will further damage their already suspect credibility. So it will be very interesting to hear what Yellen has to say today.