Key Questions on the Path to "Normal": The U.S. Case

Key Questions on the Path to “Normal�: The U.S. Case Global Interdependence Center, SUERF -The European Money and Finance Forum and Deutsche Bundesbank Conference The views expressed in this presentation do not represent those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or anyone other than the presenter. If you think you heard otherwise, you are mistaken.

Frankfurt, Germany February 8, 2018

The view from the FOMC (as of December): Slow and steady goes the policy rate.

Fed Funds Rate Projection percent

3.5

Actual

3.0

Projected

2.5

2.0

1.5

1.0

0.5

0.0 2015

2016

2017

2018

2019

2020

Note: The red line is the median projection; shaded bars represent the “central tendency� range of projections.

Sources: FRB FOMC Summary Economic Projections Dec 2017

2

The watch list • Will inflation finally (b)reach the 2 percent longerrun target?

• How big a bump from tax reform?

• Whither r*?

3

A concern: If the inflation goal is 2 percent, we have running soft for 5 years.

PCE Price Index year-over-year percent change, monthly

4.0 3.5 3.0 2.5

FOMC’s inflation target

2.0 1.5 1.0 0.5 0.0 -0.5 10

11

12

13

Sources: Bureau of Economic Analysis; FRB Dallas; Haver Analytics

14

15

16

17 4

An observation: If the inflation goal was 1.75 percent, the inflation rate of the past 5 years would look just about right.

PCE Price Index year-over-year percent change, monthly

4.0 3.5 3.0 2.5

FOMC’s inflation target

2.0 1.5

Hypothetical 1.75 percent target

1.0 0.5 0.0 -0.5 10

11

12

13

Sources: Bureau of Economic Analysis; FRB Dallas; Haver Analytics

14

15

16

17 5

Our survey indicates many businesses believe the Fed is most worried about inflation rising above 2%.

Firms' Perception of Federal Reserve's Tolerance for Inflation Above/Below its Inflation Target percentage of responses

38%

40% 35% 30% 25%

25%

22%

20%

15%

15% 10% 5% 0%

more likely to accept inflation above its inflation target

more likely to accept inflation below its inflation target

equally likely to accept inflation above or below its inflation target

Source: Atlanta Fed Business Inflation Expectations (BIE) Survey, April 2017

Unsure

6

Decomposing the recovery’s soft inflation numbers: Expectations, slack, import prices, and we just don’t know.

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

7

Why was inflation below target in 2017: “We just don’t know.”

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

8

Notable: The contribution of import prices (the green areas) has been negative for nearly 5 years – substantially so as the dollar was appreciating.

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

9

Also notable: The contribution of ‘slack� (the red areas) has disappeared.

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Bank of Philadelphia, Federal Reserve Board FAME Database,

10

The watch list • Will inflation finally (b)reach the 2 percent longerrun target?

• How big a bump from tax reform?

• Whither r*?

11

The question: If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures in 2018?

Results from the Survey of Business Executives, Nov. 13-24 2017 Percent of total responses 70 60 50 40 30 20 10 0

Decrease by 10% or more

Decrease by less than 10%

No material change

Increase by Increase by less than 10% more than 10% 12

Survey results: Positive responses to the capital expenditures skewed to smaller firms Results from the Survey of Business Executives, Nov. 13-24 2017 Percent of responses indicating increases in planned capital spending 45 40 35 30 25 20 15 10 5 0

Small Firms (0 to 99 employees)

Medium-sized Firms (100 to 499 employees)

Large Firms (500 employees or more)

13

Tax reform hits just as the U.S. economy is (arguably) entering the “high pressure” zone.

12

10 1971:Q4

8

1964:Q3

1978:Q2

1987:Q3 1997:Q1

2005:Q4

6

4 2

“High pressure” periods, where the unemployment rate falls below its natural rate.

0 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

14

Historically, “high pressure” periods have not ended well.

“High pressure” periods.

12

10 1971:Q4

8

1978:Q2

1987:Q3

1964:Q3

1997:Q1

2005:Q4

6

4

2

0 1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016 15

Beware the spurious correlation: Case study 2

Source: http://www.tylervigen.com/spurious-correlations

16

Worth noting: Historically, expansions have also ended (and inflation has risen) when oil prices spike.

Real Oil Prices

West Texas Intermediate

dollars per barrel

60 50 40 30 20 10 0 60

65

70

75

80

85

90

95

00

05

10

15

Note: Real oil prices calculated in 1982-1984 dollars using the consumer price index Source: Bureau of Labor Statistics; Energy Information Administration; Haver Analytics

17

The watch list • Will inflation finally (b)reach the 2 percent longerrun target?

• How big a bump from tax reform?

• Whither r*?

18

Another relevant picture? The term structure of interest rates

Laubach-Williams Estimate of r* annual percent 7 6 5 4 3 2 1 0 -1 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 through Q4 2017 Source: This is the one-sided version of the Laubach-Williams estimate. For definitions and data sources see the documentation for the Federal Reserve

19

Another relevant picture? The term structure of interest rates 10 Year / 2 year Treasury Note Spread percent

4

5 4.5

3 4

2

3.5 3

1

2.5

0

2 1.5

-1

1

-2 0.5

-3 1984

0

1988

1992

1996

2000

2004

2008

2012

2016 20

Key Questions on the Path to “Normal”: The U.S. Case