U.S. Outlook and Implications GIC Central Banking Meeting May 13, 2015 Madrid Daniel Sullivan Executive Vice President and Director of Research Federal Reserve Bank of Chicago
The views expressed herein are those of the author and do not necessarily represent the views of the Federal Reserve System or the Federal Reserve Bank of Chicago. 0
Another Q1 Pothole ‌ Real GDP Growth (percent change, annual rate) 6
Blue Chip Forecasts as of May 2015 3
0 Q1-2015 -3
-6
-9 2007
'09
'11
'13
'15
17
1
But Employment Growth Remains Robust Private Nonfarm Payroll Employment (change, thousands) 500 Monthly change
3-month average
0 Apr-2015
-500
-1,000 2007
'09
'11
'13
'15
2
Lowflation Is The Bigger Concern PCE Price Index (12-month percent change) 5
4 Total 3 FOMC Long-run Target
2 1
Core
FOMC Projections* Core and Total
0
Mar-2015
-1 -2 2006
'08
'10
'12
'14
'16
*Midpoint of the central tendency of the forecasts made by FOMC participants as of March 18, 2015
3
Forecasting Inflation Is Hard Core PCE Inflation (Year-over-year percent change) 2.5
Actual
Target
2.0
1.5 FOMC Projections* Q1-2015 1.0
0.5 2006
'08
'10
'12
'14
'16
* Projections taken from the first release of the Summary of Economic Projections of the Federal Open Market Committee for each year from 2010 to 2015.
4
Why Expect Inflation To Return To Target (1) Tightening labor market
– Much closer to full employment now (2) Upward pull from inflation expectations
– Fed credibility has kept expectations pretty well anchored (so far) Confidence level
– – – – –
Wishful thinking? Somewhat confident? Reasonably confident? Highly confident? Metaphysically certain?
5
Unemployment At CBO’s Natural Rate Unemployment Rate (percent) 12
Actual Unemployment 9
Apr-2015 6
CBO Short-run Natural Rate
3 1982
'86
'90
'94
'98
'02
'06
'10
'14
'18
6
But Wage Growth Has Been Slow To Improve Hourly Compensation (4-quarter or 12-month percent change) 5
Average Hourly Earnings Private Production Workers 4
Consistent With 2% Inflation? 3 Employment Cost Index
Q1-2015
2 Apr-2015 1 2002
'04
'06
'08
'10
'12
'14
7
Will Labor Share Decline Continue Or Reverse? Nonfarm Business: Labor Share of Income, All Persons (percent, SA) 65
63
61
59 Q1-2015 57
55 1971
'76
'81
'86
'91
'96
'01
'06
'11
8
Labor Force Participation Below Trend (percent) 68 Trend plus Cyclical Adjustment*
Actual
66
Trend*
64
Apr-2015 62 1984
'88
*FRBCHI staff estimates
'92
'96
'00
'04
'08
'12
9
Labor Force Participation Long-run LFP trend declining
– Demographics and – Other trends predating recession (Daniel) Aaronson et al model: LFP 1.2 % points below trend
– Suggests additional slack Decline in LFP not uniform
– Young people down sharply – Older people increasing Additional point: Education levels rising Implication: Lower natural rate of unemployment
10
Aging Labor Force Reduces Unemployment Share Of Labor Force In Age Group
Unemployment Rate
(percent)
(percent)
25
30 Ages 55 and Older
20
24
Ages 16-19 15
18 Ages 20-24
10
12
5
6
Ages 20-24
Ages 16-19 Ages 55+ 0 1982 '86
'90
'94
'98
'02
'06
'10
'14
0 1982 '86
'90
'94
'98
'02
'06
'10
'14
11
More Education Also Reduces Unemployment Share Of 25 Years And Older Labor Force By Educational Attainment
Unemployment By Education Level For Those 25 And Older
(percent) 40
(percent) 20 College Graduates Less than HS
HS Graduates 16 30 Some College
12
20 HS Graduates 8
Less than HS 10
Some College 4 College Graduates
0 1982 '86
'90
'94
'98
'02
'06
'10
'14
0 1982 '86
'90
'94
'98
'02
'06
'10
'14
12
Implications For Natural Rate Change in age, sex and educational attainment distributions should be
lowering natural rate of unemployment Assuming the CBO was correct about u* in 2005 H2 … … And also about the increase in u* post-2007 …
– Rose by 1 percentage point from 2007 to 2012 – Slowly declining after 2012 … Current natural rate at 4.9%
– See (Daniel) Aaronson et al
13
Actual Unemployment Rate Versus Natural Rate Unemployment Rate (percent) 12
Actual Unemployment
9
Apr-2015 6
3 1982
CBO Short-run Natural Rate Natural Rate adjusted for age, sex, and education changes to the labor force '86
'90
'94
'98
'02
'06
'10
'14
'18
14
Alternative Natural Rate Estimates Several small changes to methodology suggest a natural rate
between 4.8% and 5.0% – Depending on different adjustment variables and assumptions about when economy was last at full employment Adjusting the level of u* to better fit past inflation data lowers the
estimate further – to 4.3% – Simple Phillips curve specification – Lots of uncertainty – 4.3 plus or minus 1.0 – Not my baseline, but illustrates the uncertainty – Lots of uncertainty – Natural rate could be higher – Or lower
15
Most (Not All) Labor Measures Nearing Normal Worst Since 2008
Recent 3 Month Average
Current Benchmark
Percent of Gap Recovered
10.0
5.5
4.9
86
Short Term Unemployment Rate (<27 weeks)
7.0
3.9
3.7
93
Medium Term Unemployment Rate (5-26 weeks)
4.9
2.2
2.0
89
Long Term Unemployment Rate (>26 weeks)
4.4
1.7
1.3
83
Labor Force Participation
62.7
62.8
64
15
Employment-Population Ratio
58.2
59.3
60.5
62
Payroll Employment (Millions)
129.7
141.2
143.6
68
Quit Rate, Private Industry
1.4
2.2
2.2
100
Part Time for Economic Reasons Rate
6.0
4.2
2.0
42
Unemployment Rate
16
Consumers’ Inflation Expectations Stable U of M: Expected Increase in Prices (percent) 6
5 1 year
4
3
5 years
Apr-2015
2
1 2006
'08
'10
'12
'14
17
Professional Forecasters’ Slightly Less So SPF: Median PCE Average Inflation
SPF: Median CPI Average Inflation
(percent)
(percent)
3.0
3.0
5 years 2.5
2.5 10 years 10 years
2.0
2.0 Q1-2015
5 years
Q1-2015
1.5
1.5
1.0 2005 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15
1.0 2005 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15
18
TIPS Inflation Compensation More Wobbly Implicit Inflation Compensation Embedded in TIPS (percent) 3.0
2.5
06-May-2015 2.0
1.5 5-10 YR ahead: 1.96% 0-5 YR: 1.80% 1.0 2012
2013
2014
2015
19
Headwinds Many disappointments during this recovery Drag from rest of world
– Effects of higher dollar should be mainly transitory Drag from fiscal belt tightening
– Mostly over Drag from household balance sheet repair
– Definitely some progress, but perhaps more to go Natural rate of interest seems to have fallen
– Persistently, if not secularly – Uncertainty higher than normal
20
Clairvoyance Would Be Great If we knew …
– Natural rate of unemployment was high – Natural rate of interest was high … Then raising rates sooner / faster would be best
If we knew …
– Natural rate of unemployment was low – Natural rate of interest was low … Then raising rates later / slower would be best
21
Risk Management Since we’re not clairvoyant, we need to think about which
mistake is worse: If too late/slow to tighten policy …
– Inflation may go above target – Might have to raise rates more … Face a problem we know how to fix
If too early/fast to tighten policy … – Inflation may not rise to target – Rates might go back to ZLB
… Face a more difficult problem See Evans et al 22