Fed's Inflation Talk: Loosened or Gaslighting?

The Federal Reserve's recent communication on inflation expectations has sparked a heated debate among economists and market participants. Federal Reserve Bank of Richmond President Tom barkin stated that inflation expectations have "loosened, not de-anchored," a nuanced distinction that has left many scratching their heads. But is this just a clever way to manage public expectations, or is it a sign of deeper issues within the Fed's communication strategy?



The term "loosened" suggests that inflation expectations have become more flexible, while "de-anchored" implies that they have completely detached from the Fed's target. Barkin's choice of words aims to convey that while inflation expectations have shifted, they are still within a manageable range. However, economist Craig Shapiro has criticized the Fed for "gaslighting the public" by using new terminology to suggest that inflation expectations remain well-anchored. Shapiro's reaction highlights how the Fed's language can be perceived as an attempt to manage public expectations, potentially leading to market reactions that reflect either trust or mistrust in the Fed's messaging.

The data shows that greater perceived independence and trust in the Fed are associated with lower inflation expectations, a reduced perceived inflation target, and lower uncertainty about inflation and unemployment. This suggests that a loss of trust in the Fed could result in higher inflation expectations, which could in turn lead to higher actual inflation rates as businesses and consumers adjust their behavior accordingly. For instance, the data shows that "the sentiment in the Chairs’ communications plays an important role in moderating the potential surprises in the Fed announcements, and it can be effectively used as a tool for controlling and measuring monetary policy shocks." This suggests that the Fed's communication strategy is crucial for maintaining investor confidence and stabilizing the economy.

Furthermore, a loss of trust in the Fed could also lead to increased volatility in financial markets, as investors may become more uncertain about the future path of interest rates and inflation. This could make it more difficult for businesses to plan for the future and could lead to a decrease in investment and hiring. For example, the data shows that "the surprise variable for the second identification method in the Online Appendix, is constructed to disentangle the reaction of interest rates to the communication’s sentiment, uses the “surprise” of the interest rate market after the FOMC meeting decision release." This suggests that the Fed's communication strategy is crucial for managing market expectations and reducing volatility.

In summary, the Fed's choice of words when discussing inflation expectations can have significant economic implications. While the Fed may be trying to convey a nuanced message, the public and market participants are closely scrutinizing their language, and any perceived inconsistency can lead to skepticism and potential market volatility. Therefore, it is crucial for the Fed to maintain its credibility and communicate effectively with the public to manage these risks.