Are we getting inflation right? With Neel Kashkari

Episode Summary

Executive Summary: Neil Kashkari argues the post-pandemic inflation surge came from multiple shocks—goods demand shifts, supply-chain breakdowns, fiscal/monetary stimulus, and the Ukraine war—while Fed models missed it because they focused too narrowly on labor-market tightness and expectations. He says the U.S. economy remains resilient, suggesting policy may not be as restrictive as thought, so the Fed should stay in wait-and-see mode longer to protect credibility.

Main Topics: Origins of the inflation surge (Priority: 5/5): Kashkari says inflation was driven by a combination of pandemic-era demand shifts toward goods, supply-chain disruptions, policy stimulus, and Russia’s invasion of Ukraine pushing up commodity prices. Why Fed models missed inflation (Priority: 5/5): He criticizes traditional Fed frameworks for overrelying on two channels—unanchored expectations and Phillips-curve labor-market pressure—both of which were inconsistent with the evidence in 2021. Reassessment of monetary policy stance (Priority: 4/5): Kashkari explains his shift from dovish to more cautious/hawkish as circumstances changed, emphasizing that the labor market was a poor guidepost for forecasting inflation in both the low-inflation and high-inflation periods. Is policy actually restrictive? (Priority: 5/5): He notes surprising resilience in GDP, consumption, housing, wages, and unemployment, raising the possibility that the current policy rate may not be exerting as much downward pressure as expected. Neutral rate and long-run outlook (Priority: 4/5): Kashkari distinguishes short-run elevated neutral rates from a likely lower long-run neutral level, citing structural and cyclical forces like housing shortages, immigration, productivity, and AI uncertainty. Framework review and credibility (Priority: 4/5): He argues the Fed should learn from this episode without abandoning useful framework features, and warns strongly against changing the inflation target or declaring victory too early because credibility is hard won. Public anger at inflation (Priority: 3/5): He reflects on the social damage from inflation, noting that many households dislike inflation more viscerally than recession because price increases affect everyone and offer fewer coping mechanisms.

Key Arguments: Inflation was the product of several simultaneous shocks, not a single cause, and no standard Fed model would have predicted the magnitude and persistence of the surge. Traditional forecasting tools failed because inflation rose when unemployment was still elevated and expectations remained anchored, undermining the usual labor-market and expectations channels. The labor market has been a poor predictor of future inflation in both directions: it failed to generate inflation in the pre-pandemic years and also did not explain the 2021–22 surge. Current U.S. economic resilience suggests monetary policy may be less restrictive than forecasters expected, possibly because the short-run neutral rate is higher than assumed. The Fed should remain patient and keep rates steady until inflation data clearly show a durable return toward target, rather than rushing to ease. The risk of loosening too soon is greater than the risk of staying too tight a bit too long because long-run inflation credibility is valuable and hard to rebuild. The Fed should not raise its inflation target in response to the episode; doing so could unanchor expectations in future downturns. Public frustration over inflation is rational because inflation hits everyone at once, unlike recessions where households can rely on informal support networks.

Data Points: Recording date: May 27 - Episode was recorded before the Fed blackout period. Fed presidency: Since 2016 - Kashkari has led the Federal Reserve Bank of Minneapolis since 2016. Core inflation threshold: Above 2% - Core inflation first ticked above the Fed’s target in April/May 2021. Unemployment rate: 6% - Kashkari notes unemployment was still around 6% when inflation began rising in 2021. Fed policy rate: 5.25% to 5.5% - Current policy range discussed as potentially not as restrictive as expected. Unemployment rate current: 3.9% - Kashkari cites the low current unemployment rate as evidence of labor-market resilience. Inflation prior to pandemic: 1.5% to 1.6% - He says inflation was persistently below target for years before the pandemic. Inflation target: 2% - Fed’s long-run inflation objective referenced throughout the discussion. Real rate estimate: Around 0.5% - Kashkari’s estimate of long-run neutral real interest rate. Implied federal funds rate: Around 2.5% - His implied long-run nominal policy rate if the real neutral rate is 0.5%. Inflation expectations horizon: 40 years - He credits anchored expectations since the early 1980s with supporting decades of economic prosperity. Policy concern: 3% or higher - He says current and near-term inflation may be settling closer to 3% than 2%.

Pivotal Quotes: "the labor market was a lousy indicator for forward inflation" — Neil Kashkari: He explains why he no longer relies on labor-market conditions as the main signal for future inflation. "the risk of loosening too soon is a costlier risk than the risk of keeping policy somewhat too tight for too long" — Neil Kashkari: He frames the Fed’s policy tradeoff and prioritizes protecting credibility. "Inflation is worse than a recession" — Labor leader cited by Kashkari: He recounts a conversation that changed his understanding of public attitudes toward inflation.

Implications: The Fed is likely to stay patient, prioritize credibility, and avoid premature cuts. For markets and households, this implies higher-for-longer rates until inflation clearly trends back to target.