The (PCE) price level will be 135.207 in January 2030

Or at least it better be.

Powell says there’s no strict mathematical formula; but it’s pretty obvious to me that the markets and pundits are going to hold the Fed accountable. People think in terms of decades, and this policy was announced in 2020. Thus markets will naturally see this a commitment for inflation to average 2% over the 2020s. Since the PCE price level was 110.917 in January of this year, it needs to be close to 135 in January 2030. A slight miss would not be a problem, but a big miss (say average inflation outside the 1.8% to 2.2% range) would be seen as a policy failure. The Fed would lose credibility.

I also have a post on the speech over at Econlog.


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26 Responses to “The (PCE) price level will be 135.207 in January 2030”

  1. Gravatar of Garrett Garrett
    27. August 2020 at 08:57

    10y breakeven is currently 1.767%. The Fed should buy inflation swaps to punish the doubters

  2. Gravatar of Garrett Garrett
    27. August 2020 at 08:58

    Sorry, 1.767% is the 30y; the 10y break is 1.745%

  3. Gravatar of Tom Tom
    27. August 2020 at 09:02

    Using TIPS, what 10-Year breakeven inflation rate would show that the market does not believe the Fed?

  4. Gravatar of ssumner ssumner
    27. August 2020 at 09:19

    Garrett, You said:

    “The Fed should buy inflation swaps to punish the doubters”

    Yes they should, and (ironically) that would help them to implement the policy.

    Are inflation swaps a pure inflation bet, without any bond market exposure?

    Tom, An inflation rate of 2% (PCE) is about 2.3% on the CPI used for TIPS indexing.

  5. Gravatar of Garrett Garrett
    27. August 2020 at 10:15

    See here for more info on the swap:
    https://www.investopedia.com/terms/z/zero-coupon-inflation-swap.asp

    It’s a pure inflation bet, equivalent to going long a principal STRIP off a TIPS and short a principal strip off a fixed-rate Treasury. At maturity the counterparties would exchange cash based on the direction and the magnitude of the cumulative difference between the agreed rate at initiation and the growth rate of the inflation index (which would be US CPI Urban Consumers NSA).

    That said, you can’t actually do that trade in strips in any sort of size, so the dealer would have to hedge the trade with coupon-paying bonds. The dealer would factor that exposure into the rate they give you on the swap.

  6. Gravatar of bill bill
    27. August 2020 at 11:20

    I guess the Fed could announce that it’s done a billion bucks of that 10 year swap and that it will buy a billion a day until the swap is within a range of 2.2% to 2.4%. How many days would it take? 5 or 6 maybe?

  7. Gravatar of ssumner ssumner
    27. August 2020 at 12:02

    Thanks Garrett.

  8. Gravatar of Garrett Garrett
    27. August 2020 at 12:30

    To add on about inflation swaps, the 10y zero coupon swap is actually trading around 2%: https://ibb.co/Jmf7bfW

    So the market is pricing in the lower bound of your PCE range (1.8% = ~2% CPI)

  9. Gravatar of Gene Frenkle Gene Frenkle
    27. August 2020 at 13:13

    Ipso facto, now is the perfect time to pay reparations to descendants of American slaves. We should also be funneling money to middle class families with small children because they spend every dime they get!

  10. Gravatar of bill bill
    27. August 2020 at 15:35

    Serious question.
    It seems like the primary difference between an Average target and Level targeting is that Average targeting will be more procyclical versus countercyclical for Level targeting?

  11. Gravatar of Benjamin Cole Benjamin Cole
    27. August 2020 at 15:58

    To become credible, the Fed may have to indicate that regular additions to its balance sheet are permanent.

    MMT in drag?

    Or money financed fiscal programs?

  12. Gravatar of Benjamin Cole Benjamin Cole
    27. August 2020 at 16:18

    Add on. The Swiss National Bank has accumulated a balance sheet roughly equal to Swiss GDP in an effort to tame the appreciating Swiss franc. As the Swiss franc is now reaching five-year highs against the US dollar, the betting is that the Swiss central bank will again intervene in exchange markets.

    Also, see Japan.

    Certainly, there is a argument that to have credibility a central bank must indicate it is willing to permanently build balance sheets.

    Fine by me, but I wonder what others think of this policy.

  13. Gravatar of Tacticus Tacticus
    28. August 2020 at 03:49

    I just wish there were a better acronym for Zero Coupon Inflation Swaps. Half of finance is the acronyms. And it’s not even that hard to think of options: Zero-coupon Inflation Protection Swaps, ZIPS, would be so much better.

  14. Gravatar of Garrett Garrett
    28. August 2020 at 04:19

    Tacticus, the ticker in Bloomberg for them is USSWIT[Tenor], so you could call them SWITs if you wanted to

  15. Gravatar of Tacticus Tacticus
    28. August 2020 at 05:36

    Yeah, I know. SWITs is obviously way better than ZCIS, which I’ve never heard any two people pronounce the same, but I want some sort of rhyme with TIPS. I know, I know; I ask for too much 🙁

  16. Gravatar of Todd Ramsey Todd Ramsey
    28. August 2020 at 06:45

    Scott,

    Will you be concerned about an inflationary outbreak if the 10 year breakeven inflation rate (https://fred.stlouisfed.org/series/T10YIE) rises above 2.3%?

    How long would it have to stay above 2.3%, and/or how much would it have to increase above that, to concern you?

    These are honest questions, not trolling.

    Thanks!

  17. Gravatar of ssumner ssumner
    28. August 2020 at 07:19

    bill, Hard to say, as it depends how it’s implemented. I view the biggest difference as credibility. AIT is less credible than PLT.

    Todd, It depends how far above. 3% would be a concern.

  18. Gravatar of ssumner ssumner
    28. August 2020 at 07:21

    Garrett, Is that data publicly available?

  19. Gravatar of How will we know if average inflation targeting is working? – BIJIN WORLD How will we know if average inflation targeting is working? – BIJIN WORLD
    28. August 2020 at 09:02

    […] Commenter Garrett suggested that the Fed should now invest in long-term inflation swaps, a market that is now […]

  20. Gravatar of How will we know if average inflation targeting is working? | Share Market Pro How will we know if average inflation targeting is working? | Share Market Pro
    28. August 2020 at 09:40

    […] Commenter Garrett suggested that the Fed should now invest in long-term inflation swaps, a market that is now […]

  21. Gravatar of Garrett Garrett
    28. August 2020 at 09:44

    Scott,

    In trying to find out for you I discovered that someone commented on a blog post of yours regarding inflation swaps back in 2009:

    https://www.themoneyillusion.com/the-empires-last-stand-real-interest-rates/#comment-9644

    The BOE paper he links to can be found here:

    https://web.archive.org/web/20090224202743/https://www.bankofengland.co.uk/publications/quarterlybulletin/qb060101.pdf

    Regarding public data, it looks like Bloomberg used to let people check out pricing on inflation swaps on their website, but it doesn’t look like they do anymore unfortunately.

  22. Gravatar of Tacticus Tacticus
    28. August 2020 at 10:04

    Unfortunately I don’t think there are any free sources of SWITs (I do like it better than ZCISs, Garrett) pricing, but it never hurts to contact data providers and ask. I’ve known more than one academic who got free access to Bloomberg data on specific products by explaining their interest in it, etc.

  23. Gravatar of How will we know if average inflation targeting is working? – Econlib How will we know if average inflation targeting is working? - Econlib
    28. August 2020 at 11:01

    […] Commenter Garrett suggested that the Fed should now invest in long-term inflation swaps, a market that is now […]

  24. Gravatar of Laura Laura
    28. August 2020 at 20:24

    Holding the arithmetic mean of annual inflation equal, a rate with lower volatility will have higher compound growth. Hence I do not concur that the AIT goal, even though symmetric is adequate to pin a PLT.

    If inflation volatility is high, AIT will undershoot the PLT computed simply by compounding the AIT. Hence your goal to have the PCE level be ~135, is a goal to have very little, near zero inflation volatility… even when RGDP is anomalously low.

  25. Gravatar of How will we know if average inflation targeting is working? – CNB Reports How will we know if average inflation targeting is working? – CNB Reports
    29. August 2020 at 07:24

    […] Commenter Garrett suggested that the Fed should now invest in long-term inflation swaps, a market that is now […]

  26. Gravatar of ssumner ssumner
    29. August 2020 at 09:14

    Thanks Garrett and Tacticus, I don’t see why FRED would not publish a time series of this data. Indeed, for monetary policy purposes is there any more important data out there?

    Also, does the 10 year inflation swaps forecast differ from the 10 year TIPS spread? If so, is there a risk-less arbitrage opportunity?

    Laura, Good point, but I don’t anticipate enough inflation volatility where that distinction would be important. If I’m wrong then you are correct.

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