CorePCE,inflationtargetingandRBIsurplus

The minutes of meetings of the April FOMC meeting were released last week which showed that FOMC members were more willing to discuss about the taper compared to what the market expected. A simple word check reveals that the word “inflation” appeared in the 12 pager minutes report 55 times and the word “employment” was used 33 times.  In the section where the staff review of the economic situation is presented, the discussion veers from CPI to Core CPI to PCE to Core PCE then to an inflation measure as constructed by Federal Reserve Bank of Dallas. In short there are multiple inflation measures which the Fed and the FOMC are mindful of and fixating on a single measure (even if it is mentioned as the target one) is not of much use.

The US CPI data was released a few days back and had come higher than expectations, the PCE data will be released this week on 28^th May. The core PCE data released by Bureau of Economic Analysis which excludes the price of food and energy is the preferred measure watched by Fed for conducting its monetary policy. The Core PCE reading for the month of march was 1.8% YoY.

Ben Bernanke the former Fed chief describes the issues related with inflation and conduct of monetary policy in detail in his book The Principles of Economics. The book Is not an opinion piece but a textbook for an economics 101 course and it dates back to days prior to Bernanke taking up the mantle of Fed Chief from Alan Greenspan. Till that time (we are reading the 2003 edition) the US had not adopted a numerical inflation target. Bernanke makes the case for announcing a target and then sticking to it. He writes that such an act will increase the credibility of the central bank and better anchor inflation expectations. He fulfilled his promise when in 2012 Fed decided to make the target explicit and announced that the preferred measure of Core PCE will be kept around the 2% level.

But wait for it, the story was not over as in August 2020 the current Fed Chief Jerome Powell announced a revision to the framework by reframing the goal as average inflation target (AIT) of 2% over the long run. Readers can note that this slight inclusion of the word “average” introduces the whole rigmarole of ambiguity back in the system. Average over what period and timeframe, the markets now can’t predict the action even if the inflation reading is too high. Back to good old days of implicit targeting!

One more point which the readers should ponder is about the inflation expectations. Fed or any other Central banks for that matter regularly conduct inflation expectation surveys and publish the results. These surveys generally ask a group of respondents on their assessment of future inflation trajectory. The point to be noted is that the most visceral manifestation of price rise for the end customer is the price of food and price of petrol at the pump because these are the variables which it tackles most frequently. There seems to be a logical lacuna if we use this information to conduct a policy which will target core inflation. In India at least this point has been taken care of by targeting the CPI not the core part of it. However, in India too whenever the target number wobbles clamour regarding tracking the core CPI or Core Core CPI resurface.

Domestically the weekend was filled up with the news of higher than expected surplus transfer by RBI to government. The 99k Crore INR represents the payment for the 9-month accounting period ending March ‘21. Any windfall allows the centre to bridge the fiscal deficit gap and this news along with a reduction in a number of covid cases should support the bond markets. The 10-year benchmark bond opens around 5.98 today.