January 31, 2022 Reading Time: 3 minutes

As anticipated, the latest data show that prices continued to rise at an incredible pace in December. The Personal Consumption Expenditures Price Index (PCEPI), which is the Federal Reserve’s preferred measure of inflation, grew at a continuously compounding annual rate of 5.6 percent from December 2020 to December 2021. Inflation has averaged 3.5 percent since January 2020, just prior to the pandemic.

The Federal Reserve (Fed) is officially committed to a 2 percent average inflation target, as explained in its Statement on Longer-Run Goals and Monetary Policy Strategy. But supply constraints and a surge in nominal spending have pushed prices well above target. In December, the price level was 3 percentage points higher than it would have been had prices merely grown at 2 percent since January 2020.

Figure 1. Personal Consumption Expenditures Price Index (PCEPI) and 2-percent Growth Path

The Fed reaffirmed its commitment to a 2 percent average inflation target on January 25, 2022. But, so far, it has done little more than say it would tighten monetary policy in the coming months.

Following last week’s Federal Open Market Committee (FOMC) meeting, the Fed announced it would leave its federal funds rate target and the interest rate it pays on reserve balances unchanged. It will reduce its monthly asset purchases, but the size of the Fed’s balance sheet will continue to grow for now. None of this really amounts to tighter monetary policy, and yet the Fed seems to have convinced markets that it is serious about bringing down inflation.

Figure 2. Estimated PCEPI Inflation Expectations

Inflation expectations have gradually declined since mid-November. According to my estimates, bond markets were pricing in nearly 3 percent PCEPI inflation per year over the next five years and 2.6 percent per year over the next ten years. Now, they are pricing in around 2.6 percent inflation per year over the next five years, and 2.2 percent per year over the next ten years.

That the most recent estimate over the five-year horizon exceeds that over the ten-year horizon means bond markets expect inflation will decline over time. The FOMC has similarly projected that inflation would decline over the coming years. However, the precise estimates suggest bond markets currently expect inflation will exceed FOMC projections in the near term. The median FOMC member projected inflation would be 2.6 percent for 2022, and then fall to 2.3 percent in 2023.

At this stage, two things seem pretty clear: Inflation is high and will likely remain above target for a few years. My own view is that the FOMC is painting a rather rosy picture, and that market expectations provide a better guide for estimating inflation. Even if I am wrong and the Fed delivers on its projections, inflation will likely exceed 2 percent through 2024.

Note: The charts in this article are taken from the monthly inflation report [link for “monthly inflation report”: https://www.getrevue.co/profile/inflationreport] I produce with Florida Atlantic University student Morgan Timmann.

William J. Luther

William J. Luther

William J. Luther is the Director of AIER’s Sound Money Project and an Associate Professor of Economics at Florida Atlantic University. His research focuses primarily on questions of currency acceptance. He has published articles in leading scholarly journals, including Journal of Economic Behavior & Organization, Economic Inquiry, Journal of Institutional Economics, Public Choice, and Quarterly Review of Economics and Finance. His popular writings have appeared in The Economist, Forbes, and U.S. News & World Report. His work has been featured by major media outlets, including NPR, Wall Street Journal, The Guardian, TIME Magazine, National Review, Fox Nation, and VICE News. Luther earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Capital University. He was an AIER Summer Fellowship Program participant in 2010 and 2011.  

Selected Publications

Cash, Crime, and Cryptocurrencies.” Co-authored with Joshua R. Hendrickson. The Quarterly Review of Economics and Finance (Forthcoming). “Central Bank Independence and the Federal Reserve’s New Operating Regime.” Co-authored with Jerry L. Jordan. Quarterly Review of Economics and Finance (May 2022). “The Federal Reserve’s Response to the COVID-19 Contraction: An Initial Appraisal.” Co-authored with Nicolas Cachanosky, Bryan Cutsinger, Thomas L. Hogan, and Alexander W. Salter. Southern Economic Journal (March 2021). “Is Bitcoin Money? And What That Means.”Co-authored with Peter K. Hazlett. Quarterly Review of Economics and Finance (August 2020). “Is Bitcoin a Decentralized Payment Mechanism?” Co-authored with Sean Stein Smith. Journal of Institutional Economics (March 2020). “Endogenous Matching and Money with Random Consumption Preferences.” Co-authored with Thomas L. Hogan. B.E. Journal of Theoretical Economics (June 2019). “Adaptation and Central Banking.” Co-authored with Alexander W. Salter. Public Choice (January 2019). “Getting Off the Ground: The Case of Bitcoin.Journal of Institutional Economics (2019). “Banning Bitcoin.” Co-authored with Joshua R. Hendrickson. Journal of Economic Behavior & Organization (2017). “Bitcoin and the Bailout.” Co-authored with Alexander W. Salter. Quarterly Review of Economics and Finance (2017). “The Political Economy of Bitcoin.” Co-authored with Joshua R. Hendrickson and Thomas L. Hogan. Economic Inquiry (2016). “Cryptocurrencies, Network Effects, and Switching Costs.Contemporary Economic Policy (2016). “Positively Valued Fiat Money after the Sovereign Disappears: The Case of Somalia.” Co-authored with Lawrence H. White. Review of Behavioral Economics (2016). “The Monetary Mechanism of Stateless Somalia.Public Choice (2015).  

Books by William J. Luther

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