EconomicReason

Deluded by low inflation expectations, the Federal Reserve and thus, world monetary policy, have been drifting farther and farther away from a neutral monetary policy stance in recent years. World monetary policy is not just “behind the curve”, it has actually lost sight of the curve altogether. How did we get to this stage?

The first main actor in the unfolding drama is the Fed. The Fed is convinced of the silly notion that inflation expectations are a harbinger, if not the primary cause, of actual inflation.
Consequently, the Fed is following the strategy to fight inflation only when inflation expectations are on the rise.

Enter the public. The public has no reason to doubt the Fed’s intention and ability to keep inflation low. Consequently, as long as actual inflation remains low, inflation expectations remain low.

Monetary policy and the public have been moving in a self-reinforcing circle for several years now. The public has low inflation expectations because it has faith in the Fed, and the Fed keeps printing money as long as inflation expectations remain low. Each party has been giving the other party the impression that things are under control, while actually nobody is in control.

Tail chasing cannot last forever. Inflation is still a monetary phenomenon and not an expectations phenomenon - the game is over when actual inflation begins to deviate persistently from inflation expectations. It appears that the chickens are coming home to roost soon - we are quickly approaching the moment of truth when expectations will finally adjust to reality, and when the Fed monetary policy will turn out to have been quite off the mark during the past several years. However, it is too late now to restrain inflation from rising further.