Well-anchored inflation expectations, based on the Federal Reserve’s credibility over the past five decades, played a large part in the central bank surviving the great price and interest rate shocks of 2021.
But given the considerable policy uncertainty caused by the return of global trade protectionism and the return of mercantilism among the G-7 nations, it is not certain that inflation expectations will remain well anchored.
Our preferred metric, the Federal Reserve’s five-year, five-year forward breakeven inflation rate, stands at 2.41%, which is in line with the average between 2000 and 2025.
Read what is driving the regime change in the global economy in the latest issue of The Real Economy.
Should the administration implement a border adjustment tax or a universal tariff, or engage in protectionism through the financial channel, there is simply not a guarantee that the Fed will be able to anchor inflation expectations during an era of fiscal dominance and mercantilism.
And that means higher interest rates and inflation than firms and households have become accustomed to over the past half century.
