FAU Report: Inflation Exceeds Federal Reserve Projections

Russian Invasion of Ukraine Could Delay Monetary Policy Response

Inflation continues to outpace Federal Reserve projections, further eroding the real value of wages for workers across the nation. 

The Personal Consumption Expenditures Price Index (PCEPI) released today by the Bureau of Economic Analysis shows that U.S. prices grew at a continuously compounding annual rate of 5.9 percent over the past year. The PCEPI, the Fed’s preferred measure of inflation, has grown at an annual rate of 3.7 percent since January 2020, just prior to the pandemic.

The Fed is tasked with maintaining price stability in the United States and aims for prices to grow at just 2 percent on average. With inflation well above target, prices today are 3.6 percentage points higher than they would have been if the Fed had achieved its objective over the past two years.

Prices also have grown faster than Fed officials projected in December 2021. In their Monthly Inflation Report, Florida Atlantic University associate professor William Luther, Ph.D., and student Morgan Timmann forecast the price level based on Federal Open Market Committee (FOMC) member projections. They find that prices were 0.6 percentage points higher in January than the Fed projected in December 2021.

“The Fed’s responsibility is to keep inflation in line with expectations, and it has failed to do that,” said Luther, an economist in FAU’s College of Business. 

Inflation remained low and relatively stable over the past three decades, causing many Americans to grow accustomed to adjusting wages and prices at roughly the same rate each year. But the outlook is changing.

Unexpected inflation reduces the real value of wages, Luther explained. Workers must now renegotiate their wages if they are to keep from falling further behind.

“When workers renegotiate their wages, they must not only account for the unexpected inflation over the last year, but also the inflation that is likely to prevail over the course of their labor agreement,” Luther said.

Future inflation depends mostly on how the Fed conducts monetary policy.

Prior to November 2021, the consensus view of the Fed was that inflation was temporary. However, officials changed course late in the year and acknowledged an emerging concern for price growth, Luther said.

The Fed has since said it will tighten monetary policy to curtail inflation. It has already begun reducing its monthly asset purchases and signaled it would raise its interest rate target when the FOMC meets in March. But Russia’s recent invasion of Ukraine could delay those efforts.

“It is tempting to think higher oil prices following the Russian invasion would prompt the Fed to do even more to bring down inflation,” Luther said. “But the Russian invasion pushes prices up by constraining supplies. Fed officials might be reluctant to tighten monetary policy in the face of supply constraints because it would risk discouraging production at a time when Americans are already scaling back.”

Luther and Timmann also estimate the PCEPI inflation anticipated by bond markets, which workers might use to renegotiate their wages. According to their report, bond markets are currently pricing in around 2.9 percent inflation per year over the next five years and 2.4 percent inflation per year over the next 10 years. 

-FAU-