LONDON: The US Federal Reserve has signalled it will tolerate faster inflation for a time to cement the post-pandemic recovery and boost employment, but the side effect is likely to be a faster rise in commodity prices.
The central bank appears anxious to avoid a repeat of the slow expansion and job gains that followed the financial crisis of 2008 by adopting a more aggressive approach to stimulating the recovery.
In March, non-farm employment was still down by more than 8 million jobs compared with its pre-pandemic peak in February 2020, according to the US Bureau of Labor Statistics, leaving a large jobs gap to be filled.
After its latest meeting on Wednesday, the Federal Open Market Committee confirmed it will seek to achieve the twin objectives of maximum employment and inflation at the rate of 2% over the longer run.
The committee noted price rises have been running persistently below target, so it aims to achieve inflation moderately above 2% for some time to make up the shortfall and anchor expectations at around the 2% level.
But if the Fed leaves rates low to target the slackest part of the economy - the labour market - it must intensify pressure on capacity and prices in other parts of the economy, including manufacturing and raw materials.
Proposals for medium-term inflation-averaging have been winning adherents for some years, but the committee appears to be planning something more ambitious - an attempt to engineer a job-creating boom.
The plan is to run the economy hot to achieve faster job gains, especially among disadvantaged groups that are marginally attached to the labour force, before shifting back to inflation control later in the cycle.
But the resulting pressure on global supply chains while the Fed pursues employment increases is likely to generate significantly quicker price rises for raw materials and a range of manufactured items.
Based on breakeven rates, bond traders are anticipating US consumer prices will rise at an average rate of 2.4% over the next ten years, compared with a realised average of 1.7% per year over the last decade.
For much of the last decade, expected inflation has been higher than the outturns, implying traders tend to overestimate price pressures.
But bond traders are probably correct for now, reacting to signs the Fed is prepared to tolerate significantly faster inflation to achieve faster employment gains.
In its statement, the Fed repeated its previous concerns about a persistent undershoot in the inflation rate, but there is no evidence for this, at least not since the middle of the last decade.
Price levels and inflation rates show no significant lasting impact from the coronavirus epidemic and recession in 2019, in contrast to the prolonged fall after the recession in 2008/09 and the mid-cycle slowdown in 2015/16.
Consumer prices have risen at an average rate of just over 2% per year over the last two years, three years and five years, according to the all-items consumer price index published by the Bureau of Labor Statistics.
The only evidence for a persistent undershoot is the 1.7% increase over the last ten years, influenced by unusually slow price increases between 2013 and early 2016.
Based on the all-items consumer price index, both the rate of inflation and the level of consumer prices are in line with their long-term trend, and there is no undershoot to make up.
The Fed prefers more specialised measures of inflation, including the deflator for personal consumption expenditures, which is part of the national income and product accounts.
PCE inflation has been running at 1.6-1.8% per year over the last two, three and five-year periods, and as little as 1.5% over the last ten years, according to the US Bureau of Economic Analysis.
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