While inflation remains below the 2 per cent target, it has evolved largely as expected in July. There has been a slight increase in both total CPI and the Bank’s core measures of inflation, consistent with the dissipating negative impact of temporary price shocks and the absorption of economic slack. Nonetheless, there remains some excess capacity in Canada’s labour market, and wage and price pressures are still more subdued than historical relationships would suggest, as observed in some other advanced economies.So, the Bank tells us that inflation is currently below its 2% target, but is expected to come back to target as "excess capacity" goes away - basically a PC mechanism.
...what is troubling is five straight years in which inflation fell short of our target despite a sharp improvement in resource utilization.If anything, this understates the case. Here's a plot of year-over-year headline PCE inflation vs. the difference between the unemployment rate and the CBO's measure of the natural rate of unemployment:
In many of the models economists use to analyze inflation, a key feature is "underlying," or trend, inflation, which is believed to anchor the rate of inflation over a fairly long horizon. Underlying inflation can be thought of as the slow-moving trend that exerts a strong pull on wage and price setting and is often viewed as related to some notion of longer-run inflation expectations.This makes is sound like this "underlying inflation" thing resides in most of the models that macroeconomists work with. While some (most?) undergraduates are taught some version of IS/LM/PC with exogenous inflation expectations, no monetary economist I know tries to analyze inflation in a model with exogenous "underlying or trend" inflation. And that's certainly not a feature of typical NK models, except versions with sticky expectations. But trend inflation is indeed a variable in the Board's FRB/US model, if you have the patience to wade through the documentation. Indeed, essentially everything important in FRB/US (real GDP for example) ultimately reverts to some exogenous trend. Board governors and Board economists have certainly been known to treat FRB/US very seriously, so it's not surprising that Brainard is like-minded.
[An] explanation may be the greater proximity of the federal funds rate to its effective lower bound due to a lower neutral rate of interest. By constraining the amount of policy space available to offset adverse developments using our more effective conventional tools, the low neutral rate could increase the likely frequency of periods of below-trend inflation. In short, frequent or extended periods of low inflation run the risk of pulling down private-sector inflation expectations.What's Brainard saying? First, the real rate of return on safe assets is low. For example, here's the fed funds rate minus the 12-month inflation rate - a proxy for what we're interested in:
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.That's basically PC logic. According to the Committee, inflation may be low, but "accommodative" monetary policy will further tighten the labor market and, through a Phillips curve mechanism, make inflation come back to 2%. Why should the Fed continue to raise its nominal interest rate target? According to the Committee, that's preventative medicine. Tightening needs to occur in order to ward off excessive inflation, according to the majority of FOMC members, apparently.
If, as many forecasters assume, the current shortfall of inflation from our 2 percent objective indeed proves transitory, further gradual increases in the federal funds rate would be warranted, perhaps along the lines of the median projection from the most recent SEP. But, as I noted earlier, I am concerned that the recent low readings for inflation may be driven by depressed underlying inflation, which would imply a more persistent shortfall in inflation from our objective. In that case, it would be prudent to raise the federal funds rate more gradually.Basically, Brainard wants to see the inflation before increases in the policy rate occur. If inflation comes up, then she's in agreement with the rest of the committee. If if it doesn't come up, she would rather not have interest rate hikes. But, if the PC is inoperative, how will low nominal interest rates make inflation go up? How do low nominal interest rates cure the problem of "depressed underlying inflation" that she thinks exists?