Why is Inflation Still Low?

Why is inflation still low?

State Chamber/AIA/GIC Event Little Rock, AR November 3, 2017

The signals now suggest GDP growth is proceeding about as we expected‌

Real GDP

First Half, 2017 2.1

Q3 adv. estimate 3.0

All entries are annualized growth rates, in percent 2

‌ but there may be less underlying strength in Q3 than meets the eye.

Hurricanes?

Real GDP

First Half, 2017 2.1

Q3 adv. estimate 3.0

Final Sales

2.8

2.3

All entries are annualized growth rates, in percent 3

Consumer spending appears to be holding up‌.

Personal Consumption Expenditures

First Half, 2017

Q3 adv. estimate

2.6

2.4

All entries are annualized growth rates, in percent 4

‌ but business fixed investment?

Personal Consumption Expenditures Business Fixed Investment

First Half, 2017

Q3 adv. estimate

2.6

2.4

6.9

3.9

All entries are annualized growth rates, in percent 5

Not to worry? Most of the investment fall off is in structures – coming off of a strong (energy-related) first half.

Equipment Intellectual Property Products Structures

First Half, 2017 6.6

Q3 adv. estimate 8.6

4.7

4.3

10.9

-5.2

All entries are annualized growth rates, in percent 6

May as well not give up now.

2.3 percent is our GDP growth story, and we’re (for the most part) sticking to it.

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Headline inflation over the past 3 months remained on its 12-month trend – over ½ percentage below the FOMC’s 2-percent target.

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

Sources: Bureau of Economic Analysis; Haver Analytics

13

14

15

16

17 data through September 2017

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The story is the same if we focus on core (rather than headline) inflation‌.

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

4.0 PCE

3.5

Core PCE

3.0 2.5 FOMC’s inflation target

2.0 1.5 1.0 0.5 0.0 -0.5

10

11

12

Sources: Bureau of Economic Analysis; Haver Analytics

13

14

15

16

17 data through September 2017

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‌ and the same is true for more sophisticated measures of trend inflation, such as the Dallas Fed trimmed-mean PCE. PCE Price Index year-over-year percent change, monthly

4.0

PCE Core PCE

3.5

FRBD trimmed-mean PCE

3.0 2.5 FOMC’s inflation target

2.0 1.5 1.0 0.5 0.0 -0.5

10

11

12

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

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14

15

16

17 data through September 2017,

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What can account for persistently soft inflation?

• The world is changing

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What can account for persistently soft inflation?

• The world is changing --- Technology

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Though the Q3 pop is a hopeful sign, productivity growth has been exceptionally weak over the course of this recovery.

Business-Sector Productivity Growth

percent

Contributions to annualized growth rate** Labor quality

3.5

Capital deepening

3.0 2.5

TFP (Solow residual)

2.0 1.5 1.0 0.5 0.0

1947-1972 1995

1973-1995 1996

1996-2003 1997

2004-2007 1998

2008-2010 1999

2011-2017q3 2000

Sources: BLS, BEA and Federal Reserve Bank of San Francisco **Note: Growth rates are computed from Q4 of year prior to first year of range to Q4 of last year of range. Percent change measured by logarithmic change.

What can account for persistently soft inflation?

• The world is changing --- Technology --- Competition

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Mark-ups have risen sharply since 1980, a sign of more market concentration, not less.

Average Mark-Ups, 1960-2014 Weighted average based n firm level sales

Source: Jan De Loecker and Jan Eeckhout, �The Rise of Market Power and the Macroeconomic Implications,�

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What can account for persistently soft inflation?

• The world is changing --- Technology --- Competition --- Anxiety

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Wage growth, though somewhat higher than earlier in the recovery, is still well below pre-crisis levels.

Measures of wage, earnings and compensation growth 4-quarter or 12-month percent change

5.5 5.0

Employment Cost Index: Total Compensation

4.5

Payroll survey: Average hourly earnings

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 07

08

09

10

11

12

13

14

15

16

17

ECI data through Q2-2017, payroll

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Wage growth looks relatively soft even controlling for some of the compositional effects associated with new workers.

Measures of wage, earnings and compensation growth 4-quarter or 12-month percent change

5.5 5.0

Employment Cost Index: Total Compensation

4.5

Payroll survey: Average hourly earnings Atlanta Fed Wage Growth Tracker

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 07

08

09

10

11

12

13

14

15

16

17

ECI data through Q2-2017, Wage growth tracker and

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Perhaps nominal wage growth isn’t low at all, given fundamentals?

Nominal Wage Growth, Inflation, and Productivity percent change, annual rate over past three years

12

Productivity + Inflation

10

Compensation per hour 8 6 4 2 0 1965

1969

1973

1977

1981

1985

1989

1993

1997

2001

2005

2009

2013

2017

Notes: Productivity is nonfarm business sector output per hour worked. Inflation is the PCE price index. Compensation per hour (from BLS) includes wages and salaries of employees plus employers’ contributions for social insurance and private benefit plans. through Q3 2017

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What can account for persistently soft inflation?

• The world is changing --- Technology --- Competition --- Anxiety • Nobody believes 2 percent

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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

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The typical respondent in our Business Inflation Expectations Survey panel says 2% inflation is the target, but the target is not symmetric.

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

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What can account for persistently soft inflation?

• The world is changing --- Technology --- Competition --- Anxiety • Nobody believes 2 percent • Stuff happens 23

The smoking low-inflation gun? “Other”

Source: Janet Yellen, ”Inflation, Uncertainty, and Monetary Policy” Speech to the Annual Meeting of the National 24

Both the narrow (U3) unemployment rate and the broader (U6) underemployment rate suggest that labor utilization is about “normal”…

Unemployment (U-3) and Underemployment (U-6) Rates percent 18 17 16 15

Un(under)employment rate (U6). Includes PTER and marginally attached workers

14 13 12

(U6) 2005-2007 average

11 10

Unemployment rate (U3)

9 8 7 6 5 FOMC participants’ median unemployment rate estimate (from Sept. ’17 SEPs)

4 3 2 05

06

07

08

09

10

11

12

13

14

15

16

17

data through September 2017

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There have actually been relatively few episodes in recent history when the unemployment rate fell substantially below “normal”…

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

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… and they didn’t end well.

“High pressure” periods.

12

10

8

1971:Q4

1964:Q3

1978:Q2

1987:Q3 1997:Q1

2005:Q4

6

4

2

0 1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

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Beware the spurious correlation: Case study 1

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

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Beware the spurious correlation: Case study 2

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

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Beware the spurious correlation: Case study 3

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

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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

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Our outlook? Goldilocks would be comfortable.

2017:q4/q4

2018:q4/q4

2.3

2.1

4.2

4.3

1.5

2.0

Real GDP Growth

Unemployment Rate*

PCE Inflation

* QIV level

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Why is inflation still low?

Monthly Caps on Security Redemptions Billions of Dollars

2017 U.S. Treasuries Agency Debt and MBS

Oct-Dec 6 4

2018 Jan-Mar 12 8

Apr-June 18 12

Jul-Sep 24 16

Final cap 30 20

34

SOMA Treasury Securities Maturity Profile

Monthly

billions of dollars

80

Redemptions Reinvestments 60

Monthly Cap

40

20

0 2017

2017

2018

Federal Reserve Bank of New York and author calculations

2018

2019

2019 35

SOMA Agency Debt and MBS Pay-Down Profile

Monthly

billions of dollars

40

Redemptions Reinvestments Monthly Cap

20

0 2017

2017

2018

Federal Reserve Bank of New York and author calculations

2018

2019

2019 36

How the balance sheet will evolve? The benchmark case Projected SOMA Domestic Securities Holdings: Alternative Liabilities Scenarios

Billions of U.S. Dollars

4500

100

4000

90 80

3500

70

3000

60

2500

2021: $2.9 Trillion

Median

2000 1500

50 40 30

1000

20

500 0 2010

10 0

2012

2014

2016

2018

2020

2022

2024

Note: Figures for 2010-2016 (shaded areas) are historical settled holdings.

Source: Federal Reserve Bank of New York.

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