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Stubbornly weak inflation is shaping up as the wild card for U.S. monetary policy makers this year, with top Federal Reserve officials stumped by why it has lingered so low for so long and at odds as to what to do about it.
As the Fed wrestled through last year with deciding when to start trimming its massive bond-buying stimulus, the bulk of attention was focused on the unemployment rate, which until recently has been slow to fall following its spike up to 10 percent during the recession.
By last month, policy makers had grown confident enough in the job market to dial back on the program. Figures released Friday showed the jobless rate fell to a five-year low of 6.7 percent in December, despite the smallest monthly job gains in three years. With much of the hiring slowdown attributed to bad weather, however, many analysts say the Fed will stay on track with plans to end bond buying by late this year.
But there is a hitch: inflation has been drifting down for much of the last two years, measuring a feeble 1.1 percent in November by the Fed's preferred gauge.
The longer it lingers well below Fed's 2-percent goal, the more at least a few policy makers worry it is a sign that the recovery might not be as strong as it looks. In theory, inflation should rise as the job market heals.
"There's a lot we don't know about inflation," said Eric Stein, a portfolio manager for Eaton Vance in Boston. "I think it's certainly frustrating to them."
Both Boston Fed President Eric Rosengren and Chicago Fed President Charles Evans have referred to stubbornly low inflation as a "puzzle," and have warned that the longer it persists, the more likely it is that there is something rotten in the state of the economy.
"Most people are assuming it's temporary, but the longer we continue to not see it move back to the 2 percent goal, the more we have to be concerned that there are things going on that we have not fully incorporated in the model," Rosengren told Reuters this week.
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But understand it or not, the inflation data is key.
The U.S. Commerce Department's personal consumption expenditure index of inflation, which the Fed follows closely, is "the critical monthly statistic for analyzing Fed policy in 2014," Pimco's Bill Gross, manager of the world's largest bond fund, said in his monthly