By Michael S. Derby
NEW YORK, March 27 (Reuters) – Philadelphia Federal Reserve President Anna Paulson warned on Friday that the extended period of above-target inflation in the U.S. creates risks that the commodity shocks triggered by the Iran war may become a bigger problem, rather than a one-off adverse event.
Given the persistence of high inflation, “people have been thinking a lot about prices and talking a lot about prices, whether they’re businesses or individuals, for the last five years, six years, and so that salience” of what would normally be temporary price shocks “is amped up a little bit,” Paulson said at a San Francisco Fed conference.
“There’s a little bit more of a risk that the transmission of higher fuel prices, higher fertilizer prices, into inflation expectations is, you know, faster and maybe a little bit more durable,” she said. “I’m worried about that.”
Paulson, however, noted that “what we have now is long-run inflation expectations that are well-anchored at 2%, that’s tremendously valuable, right?” She added that a “fragile” job market that’s not creating many jobs is itself unlikely to contribute to higher inflation.
Paulson stopped short of commenting on how this landscape could affect the Fed’s near-term monetary policy. The U.S. central bank is currently in a holding pattern as it awaits data on the economic impact of the U.S.-Israeli war with Iran.
RISKS RISING
The war is generating large-scale energy price increases that will almost certainly drive up headline inflation, with a less clear impact on underlying levels of price pressures. Fed officials usually tend to look through these sorts of shocks and not respond with interest rate changes, but the size of the current troubles may change that calculus.
Fed officials are closely watching data on inflation expectations to see how spooked the public is becoming about future price pressures. Policymakers are likely to keep a closer eye on long-term expectations as nearer-term ones are generally more volatile.
Data released earlier from the University of Michigan showed expected inflation a year from now jumped to 3.8% in March from 3.4% in the prior month, while expected inflation five years from now ticked down to 3.2% from 3.3% in February.
Paulson said “the conflict in the Middle East has created new risks to both inflation and growth.”
She noted that inflation has exceeded the Fed’s 2% target for an extended period despite “significant progress” to lower price pressures. Paulson added that longer-run inflation expectations are “consistent” with that goal, but also said “they may also be a little more fragile.”
Paulson’s remarks on the current economic challenges were delivered in a speech that addressed how the rise of artificial intelligence technologies might affect the future of the economy and how the Fed might respond, noting the uncertainty of understanding in real time what is driving the current jump in productivity.
She said a jump in economic growth that could be driven by AI-driven productivity gains would be tough for the central bank to respond to, given above-target inflation.
“If inflation were at the 2% target, I would feel more comfortable being patient, keeping monetary policy on hold and waiting to see if a hypothetical growth surge puts upward pressure on inflation,” Paulson said.
“But if inflation is above 2% and has been for some time, I would be more cautious,” she said. “I would be inclined to weight the possibility of overheating more heavily in determining appropriate policy.”
(Reporting by Michael S. Derby; Editing by Paul Simao)
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