Yellen Wonders If Fed Inflation Credibility Dented on Her Watch

Federal Reserve Chair Janet Yellen has begun to openly acknowledge the possibility that the credibility of the central bank’s 2 percent inflation goal may have weakened somewhat — a surprising admission in what could be the final months of her tenure.

“I must admit that there is some evidence that inflation expectations could have slipped,” she told the National Economists Club in Washington on Oct 20. While she believes they are still well anchored and consistent with the Fed’s target, “that’s something that cannot and should not be taken for granted.”

That was no off-hand observation, even though it came in response to a question. Just five days earlier, in a speech to a banking conference in Washington, Yellen said it was an “open question” whether inflation expectations in major economies had edged lower.

If they have, that could pose difficulties for whoever heads the Fed next year. Expectations shape how households and companies act and thus help determine where inflation actually ends up. If consumers lose faith in the credibility of the Fed’s inflation objective, they will resist paying up for goods and services. Companies, in turn, will avoid handing out wage increases. It’s a vicious circle that can constrain the Fed from lifting inflation, which has been under 2 percent for most of the past five years.

“They’ve got a problem,” said Vincent Reinhart, a former Fed official who is now chief economist at Standish Mellon Asset Management Co.

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