The Nominal Anchor Still Holds

The Inflation Trauma Lingers, but the Fed’s Credibility Endures for Now

The U.S. economy has now experienced inflation above 2 percent for five consecutive years. The latest reading, the March headline PCE inflation, came in hot at 3.5 percent, raising concerns that inflation may no longer be well anchored. Some observers argue this uptick is temporary, reflecting one-off factors such as the Middle East conflict and tariffs. Others, however, see deeper forces at work: a gradual unmooring of inflation expectations, persistent fiscal pressures with deficits near 6 percent of GDP, and perhaps even a Federal Reserve that has been too slow to tighten policy.

So which is it? The textbook answer is straightforward: if elevated inflation is driven by temporary supply shocks and a credible nominal anchor remains intact, then it is largely benign. But if five years of above-target inflation, combined with the inflation scarring of the COVID era, has made households more sensitive to price increases, then one cannot simply assume a well-anchored economy that can easily see through the supply shocks.

In what follows, then, I will take a look at how well the U.S. economy is anchored. And I will do so by revisiting some of my favorite inflation indicators outside of the more common ones used by observers. Taken together, they paint a nuanced picture. American households remain deeply scarred by the inflation surge of the early 2020s and continue to watch prices far more closely than they did before the pandemic. Yet for all the concern, the broader nominal economy still appears anchored.

Household Views on Inflation

One of the clearest signs that the inflation surge left a lasting imprint on the American psyche comes from the Gallup poll data. This can be seen in the chart below which compares the two components of the Fed’s dual mandate going back to the 1960s. Although not as high as it was in the 1970s, inflation continues to dominate unemployment as the more important problem.

The persistence of the inflation concern matters. Before the pandemic, inflation barely registered as a concern for most Americans. It was simply not something households spent much time thinking about. Today it clearly is.

This development is important because inflation expectations are partly psychological. Once households begin paying close attention to prices, they become more likely to notice every price increase at the grocery store, every jump in insurance premiums, and every rise in rent. The COVID inflation surge appears to have fundamentally changed how Americans process price movements.

Still, there is an important distinction between inflation scarring and outright deanchoring. The Gallup data suggest inflation remains a nagging concern, but not one that is steadily worsening. In other words, households appear permanently more sensitive to inflation than they were during the Great Moderation years, but there is little evidence that concern is spiraling upward into a self-reinforcing inflation psychology.

The same general story emerges from consumer inflation expectation surveys. The three household inflation expectation measures shown below all remain elevated relative to their pre-pandemic levels. On the surface, that could be interpreted as troubling news for the Fed. Elevated inflation expectations are often viewed as an early warning sign that the nominal anchor is slipping.

But there is another interpretation that fits the data. These elevated readings may simply reflect inflation scarring. Households experienced the largest inflation shock in forty years. It would be surprising if their expectations immediately reverted back to the calm and complacency that prevailed during the 2010s.

Importantly, these expectation measures have not been exploding upward. They remain elevated, but relatively stable. That distinction matters. A deanchoring process typically involves expectations drifting continuously higher as households and firms lose confidence in the central bank’s commitment to price stability. We do not clearly see that dynamic today.

Still, the inflation scarring discussed above means households continue to see inflation as the bigger risk, and that is something the Fed cannot ignore. This is seen in the chart below. Based on the above Gallup data, it shows a balance-of-risk perspective where the public remains more concerned about inflation than labor market weakness.

The Fed’s cautious stance on rate cuts is consistent with the balance of risk measure. Even if the economy remains broadly anchored, households are still highly sensitive to inflation developments, meaning any renewed flare-up in prices could quickly erode confidence in the Fed’s credibility.

So while the evidence does not point to a fully unanchored nominal economy, it does suggest the Fed cannot afford complacency.

Household Revealed Preferences

The previous section focused largely on surveys. But talk is cheap. A better test is whether households are actually behaving as if they fear inflation and nominal instability.

One of my favorite places to look for answers on this question are Google searches for inflation. The figure below shows that searches for inflation remain structurally higher than they were before the pandemic. Americans are simply paying more attention to inflation than they used to.

There was also a notable recent spike in inflation-related searches whose timing closely lines up with the Middle East conflict and renewed concerns over energy prices. However, that spike appears to be fading back toward this new higher baseline rather than continuing upward. That pattern again points more toward inflation scarring than full deanchoring.

Another revealing indicator comes from Series I savings bonds. These retail savings bonds are explicitly indexed to inflation through the CPI and therefore provide protection against rising prices. As the figure below shows, demand for Series I bonds surged during the pandemic period. Unsurprisingly, households scrambled for ways to protect their purchasing power during the 2021-2022 inflation surge.

The figure also shows that as inflation began moderating, holdings of these bonds started declining as households redeemed them. But an interesting shift appears to have occurred beginning in early 2025. Investors largely stopped reducing their holdings and instead began rolling them over at relatively stable levels.

That stabilization may be telling us something important. It suggests households still want some degree of inflation insurance even after inflation has come down considerably from its peak. Again, this could simply reflect the lingering psychological scars from the COVID inflation experience. But it may also signal a growing awareness that inflation risks remain elevated in an environment of large fiscal deficits, geopolitical uncertainty, and recurring supply shocks.

Either way, households appear more inflation conscious than they were before 2020. But household psychology alone cannot tell us whether the broader nominal economy has truly become unmoored. For that, we need to look at total dollar spending in the economy.

Cross Checking with NGDP Growth

The best test of whether the nominal economy remains anchored is not survey data, Google searches, Series I bonds, Treasury market signals, or temporary swings in inflation. It is, in my view, total dollar spending relative to a stable benchmark growth path.

As I have argued before, total dollar spending, as measured by nominal GDP, provides perhaps the cleanest summary measure of nominal stability in the economy. If the nominal anchor is truly slipping, it will show up in persistently excessive NGDP growth relative to its benchmark growth path.

In an earlier post, I showed that a benchmark path for nominal GDP can be created by summing the CBO’s potential real GDP growth rate plus 2 percent for targeted inflation. Using this benchmark, the figure below shows NGDP growth recently accelerating above its benchmark path, suggesting excess aggregate demand pressures are running the economy somewhat hot.

However, most consensus forecasts expect this overshoot to fade as seen in the figure too. In other words, forecasters generally believe NGDP growth will gradually return toward its stable benchmark path rather than continue drifting upward as it did during the 2021-2022 inflation surge.

That distinction is critical. Temporary overshoots can occur even in a well-anchored nominal regime. What matters is whether households, firms, and markets believe those overshoots are temporary or persistent.

The second chart below is even more revealing.

It shows two longer-term forecasts of NGDP growth: first, the expected average NGDP growth over the next five years, and second, the expected NGDP growth five years from now over the subsequent five-year period. That latter measure effectively asks whether the economy is expected to remain anchored well beyond the current business cycle.

And the answer from the data is remarkably reassuring.

Even as near-term NGDP growth expectations surged during the pandemic inflation episode, the five-year, five-year forward measure remained extraordinarily stable. In other words, even in the midst of the largest inflation surge in 40 years, forecasters largely believed policymakers would eventually return the economy to a stable NGDP growth path near 4 percent.

That is exactly what a credible nominal anchor should look like.

To be sure, the Fed’s credibility was tested during the pandemic inflation surge. And one can reasonably debate whether policymakers reacted too slowly in 2021. But the longer-term NGDP forecasts suggest that, despite these questions, the broader public still believes the Fed ultimately remains committed to preserving nominal stability.

Conclusion

The Federal Open Market Committee’s recent decision to adopt a wait-and-see posture on interest rates therefore appears reasonable. The economy still shows signs of elevated inflation sensitivity, and households clearly remain scarred by the inflation experience of the early 2020s. But the broader nominal anchor also still appears intact.

Most importantly, longer-term NGDP expectations remain remarkably stable. That stability suggests the public still believes the Fed will ultimately keep nominal growth under control over the medium to long run.

Still, Fed officials should not become complacent.

The stability of the five-year, five-year forward NGDP measure did not emerge automatically. It reflects years of hard-earned institutional credibility built up by the Federal Reserve. And while that credibility remains intact today, it can erode if policymakers appear inattentive to persistent inflation risks.

The lesson, then, is straightforward. The nominal anchor still holds. But the Fed needs to stay focused to keep it that way.

P.S. For more on NGDP as a cross-check at the business cycle frequency, see this recent coauthored paper of mine in the IJCB.