By Steven K. Beckner

JEKYLL ISLAND, Ga. (MNI) – Although the housing component of
government price indices may be skewing the reported inflation rate
lower, there is no denying that a disinflationary trend exists,
according to St. Louis Federal Reserve Bank President James Bullard.

Bullard told Market News International late Friday he puts less
reliance on the inflation expectations findings of consumer surveys than
on spreads between regular and Treasury inflation protected securities
(TIPS), which show lower inflation expectations.

Bullard, a voting member of the Fed’s policymaking Federal Open
Market Committee, said he would prefer an explicit inflation target, but
said Fed watchers understand that the Fed’s long-term inflation forecast
is a tacit target.

The Fed’s favorite inflation gauge, the price index for personal
consumption expenditures (PCE), has a smaller housing component than the
Consumer Price Index, but it still accounts for roughly a quarter of the
index. And some have contended that inflation is being underestimated
because of the depressed state of the housing market and home prices.

Bullard acknowledged there is a measurement issue, but doubted it
is sufficiently large to change the overall disinflationary trend or to
invalidate the FOMC’s decision last week to resume quantitative easing
with $600 billion in planned Treasury security purchases.

“I think this is a great issue, and I have worried about whether
the housing component might be having undue influence,” he told MNI on
the sidelines of an Atlanta Fed conference commemorating the 100th
anniversary of the Fed’s founding on Jekyll Island.

“That issue is wrapped up with how are the rents moving in relation
to housing prices — how do housing prices feed into the imputed rental
calculation,” he said.

“But the alternative would be to say, ‘OK, I’m going to throw out
the housing component along with the food and energy component,'” he
continued. “You’ve thrown out so many prices at that point that I think
it’s not really reasonable.”

“Also if you look at a variety of measures of inflation, not just
PCE, core PCE measured from a year ago, but you can also look at the
market based pce from a year ago, look at the core CPI from a year ago,
the trimmed mean from a year ago,” he went on. “There’s the Cleveland
(Fed) median measures.”

“They all tell you pretty much the same story, that there has been
a disinflation trend in 2010, that hopefully we can arrest with our
policy here, get that turned around and moving back up,” he added.

Bullard was also asked about the wide divergence between survey
measures of inflation expectations and the “break-even” TIPS spread.

The University of Michigan’s consumer sentiment survey showed
consumers expecting 2.7% to 2.8% in five years. The TIPS spread has been
running between 1.5% and 1.6%. Another traditional inflation barometer,
gold, climbed to near $1,400 per ounce last week amidst dollar weakness
before retreating Monday.

“Gold is a traditional hedge against inflation risk,” Bullard
observed. ” So to the extent that we’re taking on some risk there
… some people want to hedge their risks by being in gold.”

“Of course, I’m the policymaker, so I’m telling you ‘No, we’re
going to keep inflation low and stable,” he said.

“On the survey measures of inflation expectations, I don’t think
those are sensitive enough to current developments in markets to give
you a rapid signal,” Bullard said. “If you look at the inflation
expectations in Japan, they tended not to move very much even when Japan
got a lot of low inflation outcomes for a long time.”

“So that’s why I like to use the TIPS-based measures of inflation
(expectations),” he continued. “Those have their own problems, but they
have the virtue of being a daily market signal of what everybody is
thinking.”

“I am aware of the other problems in those markets, but as a basic
measure, I think they’re more sensitive and more valuable to us,” he
added.

Leading up to last Wednesday’s FOMC meeting, there was speculation
that the FOMC might adopt a more explicit inflation target or perhaps a
price level target. It did not, and Bullard indicated he was not greatly
bothered by the decision to stick with the status quo.

The FOMC will be releasing a revised quarterly forecast in a couple
of weeks that will include a long-run forecast for PCE inflation, which
is expected to stay at 1.7% to 2.0%. And Bullard suggested that, for
now, that forecast is sufficient to convey the FOMC’s inflation
objective.

“I am an inflation targeting advocate,” he said. “But I also think
we have more or less an implicit inflation target that is coming out of
our SEP (survey of economic projections) because we’re all putting in
what we think is the likely outcome after five or six years.”

“That kind of gives you some sense of where the members think we
ought to land,” he said. “It’s not exactly an inflation target, but it
does give you a pretty good sense of where the Committee intends to be.”

Asked whether the public understands what the Fed’s inflation
target is, he replied, “If you ask the man on the street they may
rightly say, ‘I don’t care what they say, that’s not what they’re going
to do.'”

“So that’s a question of credibility,” he continued. “You can name
inflation targets until we’re blue in the face, and if you don’t have
any credibility it’s not going to matter.”

“But I do think that within the financial community and the Fed
watching community and the policymakers — pretty much everybody is on
board that there is an implicit inflation target, and it’s 2% or a
little bit less and that in fact it is pretty credible,” he added.

** Market News International **

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