The Inflation Conundrum, Revisited

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Introduction

I precocious published 2 articles: 1) titled, "My Investment Journey Since 2010 And Where I Am Now?" connected February 20, 2023, and 2) entitled, "Is There A Bond Conundrum?" connected January 03, 2023. This article is an important supplemental root for 2 published articles which incorporate nan issues of "The Pandemic Recession" and "The Inflation Conundrum."

The Fed's Policy Execution vs. Policy Effects

"[Federal Reserve Chair Jerome] Powell noted nan crisp tally up successful ostentation that had accompanied nan accelerated reopening of nan economy. While cautious connected nan outlook for ostentation fixed nan uncertain economical environment, Powell outline 5 reasons why nan existent elevated level of ostentation mightiness beryllium temporary. First, value pressures continued to beryllium astir evident successful nan comparatively constrictive group of equipment and services astir affected by nan pandemic and nan reopening of nan economy. Second, immoderate of nan prices astir responsible for nan run-up successful inflation, including those for utilized cars, were showing signs of moderation. Third, costs increases remained contained, pinch small grounds of that a "wage-price spiral" was underway. Fourth, long-run ostentation expectations remained anchored astatine levels accordant pinch nan Federal Open Market Committee's meaning of value stability. And last, it was not clear that nan underlying forces that had weighted connected ostentation successful nan decades anterior to nan pandemic had dissipated.

In discussing nan outlook for monetary policy, Powell noted 2 lessons from nan past arsenic applicable for nan existent situation. First, it is important not to overact to temporary increases successful inflation, fixed nan agelong lag betwixt a alteration successful nan stance connected argumentation and nan eventual effect connected economical activity. Second, what look to beryllium transitory increases successful ostentation tin go persistent if nan nationalist comes to expect higher inflation." (Joseph Gruber, "Macroeconomic Policy successful an Uneven Economy, An Introduction to nan Bank's 2021 Economic Symposium," pp. xvi - xvii, italics are mine)

We person viewed galore critics astir nan Fed's opening study connected ostentation impacted by nan Covid-19 was transitory. As shown successful nan supra lengthy quote, Powell pointed 5 reasons for nan spikes of ostentation were temporary, and offered 2 lessons.

Do you work together pinch Powell's 5 reasons and 2 lessons, assuming you're successful his position erstwhile nan Covid pandemic conscionable brings a higher level of inflation, 3 years ago? To beryllium fair, critics and commentators must judge Powell's stance arsenic a argumentation carrier, not based upon nan wide effects of nan argumentation pinch a agelong lag. The Fed and nan nationalist Inflation expectations play a important role.

Unfair information connected nan executions, based connected nan lagged argumentation transmission, is 1 of nan awesome causes of ostentation conundrum. The divergence betwixt Inflation expectations nan Fed primitively perceived and ostentation expectations nan nationalist formed yet is different important origin of ostentation puzzle.

Two Causes of Inflation Conundrum

The prolonged ostentation puzzle of nan Fed would person been caused by 2 matters.

The first 1 is that, ironically, an understatement of Fed's ain fantabulous occurrence of anchoring ostentation expectations. In different words, nan Fed easy recognized nan ostentation conundrum because location was small leeway from 2% ostentation expectations which person been good established for truthful galore years.

Taeyoung Doh and Amy Oksol of Kansas City Fed analyzed.

"Changing successful monetary actions and ostentation expectations complete past decade item really a interest for drifting ostentation expectations shaped monetary policy. Each of [multiple of LSAPs, which are] unprecedented, fierce argumentation responses had nan imaginable to amended anchor ostentation expectations astatine nan FOMC's implicit (before January 2012) aliases definitive (after January 2012) long-run targets." ("Has nan Anchoring of Inflation Expectations Changed successful nan United States during nan Past Decade?, Economic Review, Vol. 103, No. 1, 2018, p. 36)

The 2nd matter is nan clip sky of Fed Policy would widen from one-three years (before nan financial turmoil successful 2007- 09) to one-five years (until 2012), and past possibly to one-seven years since 2012 erstwhile 3rd LASP was carried out.

Also, a lengthy-time sky of 1 decade aliases truthful would return to normalize Fed's unprecedented monetary argumentation pinch accepted arsenic good arsenic unconventional tools, and nan enormously expanded equilibrium sheet.

Fed's Long-Term Inflation Forecast

According to nan caller talk betwixt Jerome Powell and John Williams, their tones would propose that Fed would lick nan puzzle already but they were still reluctant to denote it. I would judge truthful because they person improved their ostentation forecasts pinch 1) the analyzable Fed forecasting models, 2) the small-scale caller Keynesian models, and 3) the instrumentality learning approach.

The Machine Learning Approach

Aaron Smalter Hall, a information intelligence of Kansas City Fed, introduced a seminal attack to shed ray connected macroeconomic forecasting:

"[When] supplied pinch diverse and analyzable data, nan machine-learning exemplary [(The Elastic Net)] tin outperform simpler time-series models arsenic good arsenic a statement of master forecasters, pinch amended capacity astatine shorter horizon. In particular, experiments show a instrumentality learning exemplary tin place turning points successful nan unemployment complaint earlier than competing methods, suggesting that it tin supply forecasters pinch much guidance astir cyclical fluctuations than a statement aliases autoregressive forecasts." ("Machine Learning Approach to Macroeconomic Forecasting," Kansas City Fed, Economic Review, 103 No. 4, pp63-64, emphases are mine)

I'm really excited astir this article, because, I do judge that Fed possibly already adopt the Elastic Net for ostentation forecast. But still long-run forecast, specified arsenic five, seven, aliases 10 years up would not beryllium done yet.

As shown successful nan supra quote, erstwhile nan forecasting play extends from 2-3 years to 5 years aliases longer, nan insufficient supporting information and nan longer clip magnitude would make nan Elastic Net's activity little efficiently. Although it will return a agelong clip for nan Machine Learning Approach to improve, it must beryllium 1 of nan astir reliable ways to pursue.

The Concluding Comment

In immoderate case, nan FOMC will make an due schedule for expanding rates and shrinking its expanded equilibrium sheet, much much slowly than planned: Longer than 5 years, aliases possibly 10 years.

As a consequence, nan improving effort connected nan Fed's long-run inflation-forecasting models and nan persistent ostentation conundrum will tightly situation nan concerns of some nan Fed and nan nationalist successful nan agelong run.

O. Young Kwon, a NYU Ph.D. successful Economics (1980), had worked successful nan information manufacture for 10 years arsenic a Registered Investment Adviser (RIA). He taught Macroeconomics (CUNY, Staten Island) and Statistics (Rutgers, Newark) during 1979 to1981. In nan first half of 1980s, he, arsenic a full-time Research Associate, researched astatine nan Center for International Business Cycle Research (CIBCR) (with Geoffery H. Moore) connected business cycles, maturation cycles, world indicators, composite indexes, and forecast of business conditions and inflation. Prior to his world career, he was an Economist/Bank Supervisor astatine nan Bank of Korea (the Fed's counterpart) for 10 years (1963 - 73). In 1971, he visited nan Federal Reserve Bank of New York, sent by nan Bank of Korea: He studied nan long-run cardinal banking successful nan computerized environment. He had been a blimpish investor, targeting a reasonable finance extremity (inflation positive 5%), by mounting well-diversified portfolios pinch Vanguard and Charles Schwab Exchange-Traded (Mutual) Funds (ETF) successful nan agelong tally (5 to 7 years) until 2020, arsenic shown successful my various 20 articles.In caller years, importantly accrued marketplace volatility induced chiefly by nan much predominant online trading pattern, however, forces investors towards somewhat fierce trading to summation much aliases suffer less. It is simply a very superior situation to blimpish investors for illustration him. He has traded successful very short terms, based chiefly upon his (manual) existent - clip framework. It successfully provides him pinch nan turning points successful a fixed session. Now, he has invested successful very-short position (anywhere betwixt a fewer seconds and a mates of sessions) successful 2 trading accounts successful Charles Schwab and TD Ameritrade (whit 40% of his nest egg).  He besides has had 2 net savings successful Marcus: Goldman Sachs pinch (the remaining 60%), earning 1.7% of nan yearly percent output (APY) which is regular compounded and FDIC protected. (if you're an investor older than 70, my portfolio mightiness beryllium correct for you successful nan existent marketplace condition). He studied astatine NYU nether Oskar Morgenstern (Economic History, Game Theory), Wassily Leontief (Input-Output Theory), Fritz Machlup (International Finance and Trade), William J. Baumol (Economic Theory and Operations Analysis), M. Isaq Nadiri (Macroeconomic Theory), and Edward Wolff (Econometric Modelling). He worked connected various investigation projects: The input-Output Framework of nan U.S. Economy (Leontief), U.S. Productivity Measurements (Nadiri), Knowledge Distribution (Machlup), Firms, Games, Decisions (Baumol), and U.S. Household Spending and Saving Behavior (Wolff). His Doctoral Thesis nether Machlup (1980): Theory of Foreign Exchange and Economic Policy.(UCONN MA successful Economics 1975, Seoul Nat'l U BA successful Economics 1963, Kyung-gi H 1958. Pohang M 1955, and Pohang E 1952 for His Dear Alumni & Friends)