St. Louis, MO. — Over the next 18 months or so, Federal Reserve policy-makers will be looking closely at three unfolding developments:
Those were the key points emphasized by St. Louis Federal Reserve Bank President William Poole in a speech to the AAIM Management Association. As I see it, theres little reason why one should walk away from the output and inflation projections the FOMC presented to Congress in February, said Poole. The central tendency of the Board of Governors and Reserve Bank Presidents was that real GDP would increase by between 3 and 4 percent this year, and that core PCE inflation would most likely come in at 1 to 1 percent. As the April employment report vividly showed, the data can sometimes turn on a dime. When we put it all together, we get a mixed picture that doesn't require a fundamental change in the outlook.
Poole noted that the Fed's strategy for encouraging maximum sustainable economic growth has depended on maintaining stable prices. Forecasters, he said, were surprised by the pickup in inflation last year. The CPI, the best known measure of consumer prices, rose by 3 percent over the 12 months of 2004, about 1 percentage points higher than forecasters expected, said Poole. Much of this error was due to unexpectedly higher energy prices. Still, when we strip out food and energy prices, we find that CPI core inflation rose about 2 percent.
Poole emphasized that in 2005, nominal interest rates havent moved in a manner that suggests the market is beginning to price in a larger inflation premium. If anything, he said, yields on 10-year Treasury securities suggest just the opposite. Not only are they little changed since the first of the year, they are still below last Junes level when the FOMC first began its policy of bringing the federal funds target rate toward an equilibrium level. To me, that suggests that the market is confident of the FOMC's resolve to keep inflation well-controlled.
Poole said the only surprise hes seen in the past year is that there has not been a major surprise, except for energy prices. At some point, he added, well almost certainly see some surprises in the data. What should not be uncertain, however, is the Fed's ironclad commitment to maintaining price stability. Maintaining fundamental price stability is central to maximizing sustainable economic growth and the economys ability to adjust successfully to inevitable shocks.