Yellen Let the Cat Out of the Bag

The Fed has failed to deliver on its inflation target consistently.

So in the Q & A after her speech, Yellen spelled out why the FOMC expects inflation to “return” to target. It was a remarkably honest admission. This is from the FOMC Press Conference on June 14, 2017.

Yellen: [The neutral rate] is hard to pin down; especially given the fact that the so-called Phillips curve appears to be quite flat—that means that inflation doesn’t respond very much or very quickly to movements in unemployment. Nevertheless, that relationship, I believe, remains at work.

Yellen is wrong. As I have argued previously, the ‘second unbundling’ has transformed the inflation process in the core of the world economy such that global slack drives inflation; not domestic slack. More recently, Auer, Borio and Filardo (2017) have shown that the intensity of participation in global value chains explains the time-variation and the international cross-sectional variation in the strength of that relationship. They have thus tied the mutation of the inflation process directly to Baldwin’s ‘second unbundling’. How long do we have to wait before the FOMC catches up with the BIS?

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