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St. Louis Fed's Bullard Discusses the Question of When U.S. Inflation Will Return to Target

11/14/2017

LOUISVILLE, Ky., – Federal Reserve Bank of St. Louis President James Bullard gave remarks on “When Will U.S. Inflation Return to Target?” at the Economic Update Breakfast hosted by the St. Louis Fed and the Association for Corporate Growth.

In his talk, Bullard discussed the state of inflation, real economic performance and financial conditions in the U.S., and why these factors suggest the current level of the Federal Reserve’s policy rate (i.e., the federal funds rate target) “is likely to remain appropriate over the near term.”

The 2017 Inflation Surprise

Bullard noted that the U.S. inflation rate has been below the Federal Open Market Committee’s (FOMC’s) 2 percent inflation target since 2012.

“Inflation data during 2017 have surprised to the downside and call into question the idea that U.S. inflation is reliably returning toward target,” he said. He noted that the FOMC’s current median projection for core PCE inflation is 1.5 percent at the end of 2017. “If the Committee is going to hit the inflation target, it will likely have to occur in 2018 or 2019,” he added.

He said that the two most cited factors that could drive inflation higher are inflation expectations and a faster pace of economic expansion.

Inflation Expectations

Bullard explained that one important influence on actual inflation is the state of inflation expectations. “Expected inflation measures based on Treasury Inflation-Protected Securities (TIPS) remain relatively low,” he said, adding that “survey-based measures have also slipped in the last year.”

Inflation expectations can also be sensitive to oil price movements, he said, adding that while prices have recently increased due in part to political developments in Saudi Arabia, the increase would likely be limited because the U.S. tends to produce more oil when prices rise.

Real Economic Performance

Regarding the second factor that could drive inflation higher, i.e., a faster pace of economic expansion, Bullard looked at U.S. real GDP growth.

“The data since the financial crisis suggest that the U.S. has converged to 2 percent real GDP growth,” Bullard said. He added that U.S. real GDP grew at an annual rate of 2.1 percent in the first half of 2017. Meanwhile, second-half real GDP growth is showing some improvement from the first half of the year, with current tracking estimates near 3 percent.

However, “Real GDP growth will likely be slower in 2018 than it has been in the second half of 2017,” he said.

Turning to U.S. labor markets, Bullard noted that the pace of employment growth has slowed since 2015 and that the unemployment rate, at 4.1 percent in October, is relatively low. However, he said that low unemployment is probably not a harbinger of higher inflation, since the statistical relationship between unemployment and inflation has broken down during the last 20 years.

“Even if the U.S. unemployment rate declines substantially further, the effects on U.S. inflation are likely to be small,” he said.

U.S. Financial Conditions

Bullard also pointed to U.S. financial conditions, which are currently considered easy, or “low stress,” according to commonly used indexes. These indexes take into account factors such as market volatility, which has been low, and interest rate spreads, which have been relatively narrow.

“However, these indexes have an important asymmetry: High-stress readings are associated with economic weakness. Low-stress readings do not reliably predict future economic outcomes,” he explained. “The current low readings probably do not contain any important signal at this point.”

Conclusion

Bullard reiterated that inflation has surprised to the downside this year and that “inflation expectations remain below the level that would be historically consistent with the FOMC’s inflation target.”

Regarding the performance of the economy, he said that “real GDP growth looks like it may surprise to the upside during the second half of 2017 before shifting toward slower growth in 2018.” He added that low unemployment readings are probably not an indicator of meaningfully higher inflation over the forecast horizon.

In terms of U.S. financial conditions, he noted that low financial market stress readings do not have strong predictive content for the economy.

Given these factors, Bullard concluded, “The current level of the policy rate is appropriate given current macroeconomic data.”

Related: View photos of visit to Louisville.