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Dallas Fed: High Unemployment Likely to Mean Low, but Not Falling, U.S. Inflation

For immediate release: October 16, 2012

DALLAS—With long-term inflation expectations well-anchored, U.S. inflation is unlikely to fall much below 2 percent over the coming year, according to the latest issue of the Federal Reserve Bank of Dallas’ Economic Letter.

Economic Letter can be found at: /~/media/Documents/research/eclett/2012/el1212.ashx

In “High Unemployment Points to Below-Target (But Still Stable) Inflation,” Tyler Atkinson and Evan F. Koenig say that over the past 15 years, long-forward inflation expectations—the inflation rate professional forecasters think will prevail in the longer-term—have been well-anchored.

Actual inflation tends to run below long-forward inflation expectations when unemployment is high, the authors find. Conversely, when unemployment is low, actual inflation runs above long-forward inflation expectations.

The links between actual inflation, long-forward inflation expectations and the unemployment rate are clearest when extreme, “one off” price increases or decreases are first stripped from the inflation rate, as in the calculation of the Dallas Fed’s trimmed-mean PCE inflation rate.

“The best way to forecast headline inflation is to forecast trimmed mean inflation,” the authors write. “The trimming procedure filters or sifts out ‘noisy’ components from the inflation data, making it easier to discern the underlying relationship between inflation and labor market slack.”

Given the current high unemployment rate in the United States, inflation is likely to stay stable somewhat below 2 percent, the authors note, provided long-forward expectations remain anchored.

Atkinson is a senior research analyst and Koenig is a vice president and senior policy advisor at the Federal Reserve Bank of Dallas.


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