Recently, there’s been a surge in expectations for inflation over the next five years, reaching the highest levels we’ve seen in this economic cycle. This shift is raising some serious questions about the Federal Reserve’s ability to control consumer prices.
So, what’s the buzz? According to the Federal Reserve Bank of New York’s May Survey of Consumer Expectations, Americans now expect the inflation rate to be 3% over the next five years. This is a bump up from 2.8% just a month ago. Interestingly, this isn’t just a one-time spike. It’s the third consecutive month where we’ve seen inflation expectations on the rise for the five-year horizon.
Now, let’s put this into context. Just last year, expectations for longer-term inflation were on a downward trend. By December, they had dipped to 2.5% from 3% in June. But this year, things have taken a turn. The resurgence to a 3% expectation is quite significant, especially considering the Federal Reserve’s goal to bring inflation down to 2%.
Why is this important? Economists and Federal Reserve officials believe that high inflation expectations can become a self-fulfilling prophecy. If people expect prices to keep rising, they might adjust their behavior in ways that actually drive prices up. This makes the recent rise in expectations particularly worrisome for the Fed’s inflation-taming campaign.
Here’s a bit of history for you. The New York Fed only started asking about five-year inflation expectations in January 2022. Back then, the personal consumption expenditure (PCE) price index was up 6.3% from the previous year, and consumers expected a 3% inflation rate over the next five years.
As the Fed began hiking interest rates to combat inflation, these expectations dropped to 2% by August 2022. However, as inflation proved to be more persistent than anticipated, expectations crept back up, hitting 3% again by June 2023. The May survey marks the third time expectations have reached this peak.
Looking at the shorter term, the median expectation for inflation over the next three years held steady at 2.8% in May. This is just slightly above the actual year-over-year PCE inflation rate of 2.7% recorded in April. For the one-year horizon, the expected inflation rate ticked down slightly to 3.2% from 3.3%.
What does all this mean for the Federal Reserve’s strategy? The elevated near-term expectations, coupled with the rise in longer-term expectations, suggest that the public might be losing confidence in the Fed’s ability to manage inflation. This could influence the Fed’s decisions on interest rates, with some arguing that the Fed should maintain its current policy rate rather than cut it later this year.
