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Fed's Daly: Dip in inflation expectations 'bears close watching'

The Federal Reserve should closely monitor a dip in inflation expectations to ensure price growth does not get stuck below the Fed's 2% goal, San Francisco Fed President Mary Daly said March 26.

Her comments reflect some worries among Fed officials that inflation has failed to meet the 2% goal in recent years, a factor that helped drive the Fed's March 20 decision to keep interest rates unchanged.

In an appearance in San Francisco, Daly said she backs the Fed's current wait-and-see approach to interest rate moves as officials evaluate to what extent U.S. economic growth is softening.

"Patience is the way to go," she said, noting that recent data have come in "a little bit slower" than she expected.

Daly, an expert on labor markets who will become a voting member of the rate-setting Federal Open Market Committee in 2021, also laid out several potential "wedges" that may be holding down inflation, which she said has "grazed" the Fed's 2% target at times but has generally been below that mark over the past decade. The Fed's preferred inflation gauge was at 1.9% in its most recent reading, and market-based measures of inflation expectations show that investors are not yet convinced the Fed will meet the 2% goal in the next few years.

Fed Chairman Jerome Powell pointed to those trends during his March 20 news conference, saying that subdued inflation pressures globally are "one of the major challenges of our time" and that the Fed has not "convincingly achieved" its 2% target in a symmetrical way.

Those trends are worrying because they make the possibility of deflation more likely, Daly said, an issue that Japan has grappled with for decades. They also give the Fed less room during a recession to cut interest rates and boost the economy, she added.

"We need to be vigilant on this front, and work to deliver 2% inflation on a sustained basis," she said in her prepared remarks. "The Federal Reserve's continued credibility with consumers and businesses depends on it."

The labor market's strengthening has been "nothing short of extraordinary" but has failed to drive up inflation enough, Daly said, pointing to several factors that appear to be complicating the historical relationship between the two.

For one, workers have been seeing an increase in non-wage compensation measures, such as free transportation, unlimited time off, student loan repayment help and flexible workweeks. They also have seen a significant decline in bargaining power, with factors such as a decline in unionization and a rise in globalization making them less able to demand higher wages from employers.

Many companies, too, are facing "ever-increasing competition to hold onto customers" and feel they are less able to pass higher costs along to consumers.

The Fed may be playing a role too, she added. When the central bank successfully lowered inflation after the increases of the 1970s, it became "committed to keeping it" under control, and its commitment has helped keep a lid on inflation expectations.

"All of these wedges are contributing to the situation we have today: a strong economy with a tight labor market — but muted inflation," she said.