How Brutal Is the Fed Prepared to Be?

Surging prices have turned a favorite preoccupation of economists into an obsession: What do investors expect inflation to be five or more years from now? This focus follows from the reassuring idea that if long-term expectations are holding steady, future inflation will be stable too. Current events threaten to put this to the test.

The disturbances to supply and demand that pushed U.S inflation to 7.9% in the year to February were wholly unexpected — so the idea that stable expectations anchor short-term inflation is obviously wrong. Yet this fact calls into question the assumption, embedded in what the Federal Reserve and its army of watchers say about the outlook, that stable expectations do anchor inflation in the longer term. In due course, according to the standard view, inflation will somehow fall back to the Fed’s target of 2% without the central bank having to do anything too drastic.