Regarding the propagation of the relative price shocks to the overall economy – or secondround effects – one important factor is significantly related with the sensitivity of inflation  4  BIS central bankers’ speeches  expectations to the short-term behavior and the flexibility of real wages. It is possible that, if the economy sustains its dynamism beyond its installed capacity, it may foster a greater propagation of these shocks to other prices and to labor costs, heightening its inflationary effects. As I said before, the baseline scenario assumes that gaps will remain closed over the projection horizon, but the possibility remains that output and demand grow above forecasts, thus exceeding the normal use of the economy’s productive capacity and exacerbating inflationary pressures. Conversely, increased prices of fuels and other products affect the consumers’ disposable income and, thereby, can become a factor moderating expenditures in other goods and services. In the international scenario, financial tensions remain in some European countries and global imbalances are far from being resolved. There are also doubts regarding how tight output gaps are and how strong are inflationary pressures in some emerging economies, especially in Asia, and how will policy makers and investors respond to the signs of higher inflation that are appearing. Considering the experience of 2007–2008, this might trigger a monetary policy reaction that could cause a more pronounced slowdown in the demand of emerging economies, with important consequences on world growth and commodity prices.
Importantly, this sustained undershoot of the inflation target is likely to be a recurring dilemma for the Fed and central banks in Japan and Europe that have had similar experiences over the past decade. This problem of inflation running chronically below the target stems in part from the limited ability of central banks to offset economic downturns due to the lower bound on interest rates in a low-neutral-rate environment.7  Implications for the Monetary Policy Framework The risk of the inflation expectations anchor slipping toward shore calls for a reassessment of the dominant inflation targeting framework.8 A number of alternative frameworks and strategies have been proposed that hold the promise of better achieving the inflation goal and holding fast the inflation anchor. 9 In this regard, I am very pleased that the Federal Reserve is undertaking a review of our policy framework this year, a topic that Federal Reserve Vice Chairman Clarida will discuss in his lunch remarks today. In summary, the Phillips curve is alive and well. I wholeheartedly agree with the authors that we 3/4  BIS central bankers' speeches  must not be complacent about inflation expectations becoming unmoored, whether at too high or too low a level. 1  See John C. Williams, Inflation Persistence in an Era of Well-Anchored Inflation Expectations, Federal Reserve Bank of San Francisco Economic Letter 2006–27, October 13, 2006. 2 See More Amazon Effects: Online Competition and Pricing Behaviors, Jackson Hole Economic Symposium  Conference Proceedings; Federal Reserve Bank of Kansas City, 2018.