MR. FISHER: It struck me particularly yesterday that we are not hearing anything about pricing power at this table. That was our preoccupation for a while. Not one person at the table mentioned it in the way it had been mentioned in the past several conversations. We are, however, continuing to hear about the availability and the cost of labor, and some of those costs, incidentally—such as the welders and Governor Kroszner’s show-up premium—are not going to be reflected in the data.
The bottom line is that I think we’ve made substantial progress. But I think we have to be very mindful, Mr. Chairman, about perception if we’re to influence what really counts, which is inflationary expectations, and about whether those expectations are measured accurately by TIPS spreads, which I personally doubt. One need look no further than this morning’s Financial Times editorial or Bill Gross’s recent client letter—I’ve known Gross for twenty years, and I know he’s an oddball. Actually, I’d like that word struck from the record. [Laughter]
MR. MOSKOW. What do you want to substitute? [Laughter]
MR. FISHER. He’s increasingly addled, but his words do carry weight. In his recent client letter, he says, “Inflation is leveling off at admittedly unacceptable levels.” Hence my careful reference to the word “comportment.” I think first about the immediate statement, and I want to come to that.

The problem with financial market indicators is that asset prices respond to any number of risks, not just inflation.   In a world that is always confronting and evaluating risks, disentangling the inflation risk from all the other risks is a very imperfect science. Nevertheless, financial market indicators are proving to be a useful yardstick for monitoring inflation expectations...

You might think that a better way to gauge inflation expectations would be to simply ask people their views on inflation. In fact, there is a survey that does just that. Once a month, the University of Michigan interviews about 500 households around the nation, asking people how much they think prices will rise in the next 12 months and over the next 5 to 10 years. Here, too, there are some problems with interpreting the raw data. For one thing, households' beliefs about future inflation are typically much higher than the actual inflation rate.

Also, investigations into the survey data have revealed some fascinating patterns. For example, people are likely to report their inflation predictions in terms of whole numbers, and particular whole numbers at that. It turns out that people are far more likely to report that they expect 0, 3, or 5 percent inflation than 1, 2, or 4 percent.

I put the greatest weight by far on the TIPS spread because you observe it daily, hourly if you want. And I don't just trust the surveys. I think the surveys can be influenced heavily by what people are seeing on television, by the latest readings on gasoline prices.

In fact, I wouldn't be surprised with the substantial decline we've had in gasoline prices in recent weeks that you'll see the next surveys coming out down from where they were. But I don't put a whole lot of weight on the surveys.

Most of the market commentary, I think, is picking up half the story. The commentary is that the economy is perhaps soft and that the next Fed moves will be down on the Fed funds rate rather than up. So the market is anticipating some easing of monetary policy in the future. That's part of the story.

There's another part of the story, though, which is that the bond market works as a built-in stabilizer for the economy.  So the fact that rates are down is going to tend to support housing, for example, which is very, very sensitive, and other consumer durables, interest-sensitive spending.

So the bond market is serving as a built-in stabilizer and will help to keep the economy from weakening dramatically going forward. That's my expectation.

I would offer a word of caution, however, regarding over-interpreting market-based expectation measures. Paradoxically, if the Fed ever becomes perfectly credible with respect to its policy goals, the resulting credibility will destroy the information flowing back to it from financial markets: whenever the Fed looked into the mirror of the private sector, it would see reflected back only it own image. It is for this reason that I have emphasized that policymakers cannot relax—we need to do the best we can digging into information of all sorts to provide the clearest possible view down the road so that policy adjustments preempt inflation.

[W]hat we're seeing in the implications for inflation expectations in the TIPS spreads is that irrespective of the price level from which we start, inflation expectations have clearly come down about 0.3 percentage point. How much of that truly represents an underlying decline in inflation expectations is an arguable issue because the TIPS implicit price deflator is fundamentally an arguable issue to begin with.