The Outlook for Inflation Edward S. Knotek II Vice President of Economic Forecasting

Disclaimer The views expressed today are my own and not necessarily those of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Key Themes Inflation has been running at very low levels … … but recent readings have moved higher, suggesting inflation has bottomed out. Stable inflation expectations and an improving economy will gradually pull inflation up to 2 percent over the next few years.

Inflation has slowed since 2011 Year-over-year percent change FOMC’s longer-run objective PCE price index Core PCE price index Source: Bureau of Economic Analysis

Accounting for the Recent Decline in Inflation Share of decline Source ½ Subdued pace of recovery ¼ Pass-through from import prices, labor costs, energy prices Special, temporary factors Source: “Inflation: Why It Is Very Low, and Why It Matters” Federal Reserve Bank of Cleveland Annual Report 2013

Monthly inflation readings have perked up Month-over-month percent change Median CPI Source: Federal Reserve Bank of Cleveland

Monthly inflation readings have perked up Month-over-month percent change PCE price index Median CPI Core PCE price index Source: Bureau of Economic Analysis, FRB-Cleveland

Monthly inflation readings have perked up Month-over-month percent change PCE price index Median CPI Core PCE price index Nowcasts from Inflation Central Source: Bureau of Economic Analysis, FRB-Cleveland

Food inflation is part of the story Month-over-month percent change CPI: Food price index Source: Bureau of Labor Statistics

Commodity prices are already leveling off Index, 1967=100 Reuters/Jefferies CRB Commodities futures Source: Commodity Research Bureau/Haver Analytics

Services inflation remains subdued Year-over-year percent change PCE core services price index Source: Bureau of Economic Analysis

Services inflation remains subdued Year-over-year percent change Employment cost index PCE core services price index Source: Bureau of Economic Analysis, Bureau of Labor Statistics

Inflation is expected to gradually rise Year-over-year percent change PCE price index (data) Forecast Source: Bureau of Economic Analysis, FRB-Cleveland

Key Drivers of the Forecast Stable inflation expectations An improving economy and tightening labor markets that lift wage growth Winding down of special temporary factors but still some low inflationary momentum Moderate pressure from commodity prices

Inflation forecasts are very uncertain Year-over-year percent change PCE price index (data) 70 percent probability band Source: Bureau of Economic Analysis, FRB-Cleveland

Risks and Uncertainties Geopolitical uncertainties surround key energy and agricultural resources Wages: muted or poised for a pickup? Low inflation per se poses a risk to the outlook

www.clevelandfed.org/inflation-central/