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Jeremy Rudd, a senior economist at the Federal Reserve Board, challenges a key element of Fed monetary policy strategy: that the public’s expectations for inflation are a primary driver of inflationary outcomes. If firms, households, and financial markets expect prices to rise, conventional theory goes, workers will demand higher wages in anticipation and prices will actually rise as a result. The Fed, therefore, closely monitors inflation expectations and seeks to anchor them at 2%. Rudd argues that the theory behind this “is “unsound,” with little backing from historical trends in inflation. Wages are likely much more influenced by changes in the cost of living in the current period than by perceived future ones – rendering these regular Fed assurances ineffective. In fact, he suggests, “it is far more useful to ensure that inflation remains off people’s radar screens than it would be to attempt to ‘re-anchor’ expected inflation at some level.”
Alexandra Tabova of the Federal Reserve Board and Francis Warnock of the University of Virginia challenge the conventional view that foreign investors in U.S. Treasuries receive lower returns than domestic investors. Using security-level data on foreign holdings of Treasuries over the 2003-2019 period, they find that adjusting for risk, foreign investors – both private and official – do a bit better than domestic investors in the Treasury market. Private foreign investors, in particular, earn returns above the market rate. A rise in the Treasury yield relative to the sovereign yield (the rate of return on debt issued by the foreign government) causes private foreign investors to demand more Treasury securities, the authors find, challenging the idea that foreign demand for U.S. Treasuries is not sensitive to price changes. The notion that foreigners’ Treasury portfolios perform poorly likely stems from limitations of publicly available data, the authors note, which explain why their results deviate significantly from other estimates.
In response to the COVID-19 recession, the U.S. government increased the Child Tax Credit as of July 2021 and made it more widely available. Zachary Parolin of Columbia University and co-authors find that the enhanced payments significantly reduced food insufficiency among families who received them. Using household survey data from April to August 2021, the authors find that the initial payments were associated with a 25% decline in food insecurity in low-income households with children. Households with gross annual incomes below $35,000 in 2019 particularly benefitted from the expanded policy, the authors find, while those in higher income brackets were less affected, likely because they faced less hardship to begin with. “As more children receive the benefit in future months, food hardship, and perhaps other forms of material hardship, may decline further,” the authors conclude.
Chart of the week: Investors demand more yield to hold Treasury bills that mature around the time the federal debt ceiling will bind (unless Congress acts)
Source: The Wall Street Journal
“While inflation has been well above target for the past six months, affecting consumers and businesses alike, it previously spent roughly a quarter century below 2%. There are good reasons to expect a return to pre-COVID inflation dynamics due to the underlying structural features of a relatively flat Phillips curve, low equilibrium interest rates, and low underlying trend inflation. While the playbook for guiding inflation back down to target following a moderate overshoot is well tested and effective, experience suggests it is difficult to guide inflation up to target from below,” says Lael Brainard, Member, Federal Reserve Board of Governors.
“Once COVID constraints recede, I see no reason the labor market should not be as strong or stronger than it was pre-pandemic. The forward guidance on maximum employment and average inflation sets a much higher bar for the liftoff of the policy rate than for slowing the pace of asset purchases. I would emphasize that no signal about the timing of liftoff should be taken from any decision to announce a slowing of asset purchases. We have learned this summer that it is important to remain highly attentive to the data and to avoid placing too much weight on an outlook that remains highly uncertain. In implementing policy step by step, we must remain faithful to our new framework and attentive to changing conditions in order to ensure sufficient momentum as fiscal tailwinds shift to headwinds to achieve our maximum employment and inflation goals.”
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