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. 7
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
8
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
9
‌ 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
13
14
15
16
17 data through September 2017,
10
What can account for persistently soft inflation?
• The world is changing
11
What can account for persistently soft inflation?
• The world is changing --- Technology
12
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
14
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,� 15
What can account for persistently soft inflation?
• The world is changing --- Technology --- Competition --- Anxiety
16
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
17
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
18
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
19
What can account for persistently soft inflation?
• The world is changing --- Technology --- Competition --- Anxiety • Nobody believes 2 percent
20
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 21
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
22
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
25
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
26
… 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
27
Beware the spurious correlation: Case study 1
Source: http://www.tylervigen.com/spurious-correlations
28
Beware the spurious correlation: Case study 2
Source: http://www.tylervigen.com/spurious-correlations
29
Beware the spurious correlation: Case study 3
Source: http://www.tylervigen.com/spurious-correlations
30
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
31
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
32
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. 37