Jérôme DEYRIS (Sciences Po, CEE), Interests and prices: The politics of inflation diagnosis at the Fed

Abstract: The COVID inflation proved once again that understanding the drivers of inflation in real time is challenging. Yet accurate diagnosis is critical: different causes of price increases demand different policy responses with far-reaching distributional consequences. Informed by available data and prevailing theories central bankers must navigate this uncertainty to deliver optimal monetary policy. But are economic fundamentals the sole driver of their diagnosis or do political institutional and individual factors also play a role? Are Fed officials always transparent about what drives inflation or do private deliberations diverge from public messaging? Our paper answers these questions focusing on the Federal Reserve case. We leverage large language models (LLMs) to systematically analyze private FOMC deliberations and public speeches since 1970 making three main contributions. First we document how different inflation explanations (Fiscal, Labor, Energy, Commodities, Exchange rates, and Profits) waxed and waned over fifty years. In the short run these allow us to trace how central bankers coped with external developments and made sense of contemporaneous price increases. In the long run they illustrate the rise and demise of alternative inflation theories from fiscal explanations to wage price spirals. Second we compare private and public explanations of price increases revealing systematic divergences. Certain drivers appear systematically more prominent in public (Fiscal and Energy) while others are mainly discussed in private (Profits and Labor). This suggests that Fed officials engage in strategic reputation management carefully curating their inflation narratives to protect institutional legitimacy. Last we investigate what shapes Fed officials’ attribution of inflation to Labor the most frequent cause of inflation in our corpus. While there is no relationship between low unemployment and Labor blame in public speeches private deliberations reveal a strong negative relationship indicating the Phillips curve is alive and well just hidden from public view. Crucially this “fear of full employment” is not only dependent on economic fundamentals: it intensifies under Democratic administrations suggesting that inflation diagnosis is also influenced by politics.