Economic Outlook and Monetary Policy Global Interdependence Center and Financial Planning Association Sarasota, FL February 17, 2017
Daniel Sullivan Executive Vice President and Director of Research Federal Reserve Bank of Chicago The views I express here are my own and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.
The Fed Has A Dual Mandate Full employment
– (Rough) Meaning: Unemployment near its (time-varying) natural rate – with due allowance for other measures of slack – Current state: Likely very close to -- but perhaps not quite at -full employment Stable prices
– (Exact) Meaning: Inflation as measured by PCE price index symmetrically near 2% over the medium term – Current state: Making progress, but continuing to fall short of target
Continued Moderate GDP Growth Real GDP Growth (Q4/Q4 percent change) 4 FRBCHI Potential
2017-2018 FRBCHI Forecast Average
Actual GDP
2
0 2016: 1.9%
-2
-4
2006
'08
'10
'12
'14
'16 H1/H2
'18
* Source: Data from the Bureau of Economic Analysis, accessed via Haver Analytics, and FRBCHI staff estimates.
Fed Nirvana?: Steady, Boring Growth
“Personally, I liked this roller coaster better before the Federal Reserve System got hold of it.�
4
Recent Spending Data Consumption: Solid Growth Home building: Continuing modest uptrend
Business investment: Now showing modest increases
– But that’s an improvement over 2016:Q1-Q3 Net exports: Higher dollar will continue to slow exports Adds up to moderate growth this quarter and likely the
next several quarters
Employment Growth Remains Robust Nonfarm Payroll Employment (change, thousands) 400 Data Growth Necessary To Absorb Increase In Labor Force* 300
Jan-2017 200
100
0
2011
'12
'13
'14
'15
'16
'17
Source: Data from the Bureau of Labor Statistics, accessed via Haver analytics. * Data based on Chicago Fed Letter, “Is There Still Slack in the Labor Market?�, by Daniel Aaronson, Scott A. Brave, and David Kelly.
Unemployment Likely Very Near Natural Rate Unemployment Rate (percent) 11
9
Actual Rate 7
Jan-2017
5 Natural Rate* FRBCHI Forecast* 3 2000
'02
'04
'06
'08
'10
'12
Source: Data from the Bureau of Labor Statistics, accessed via Haver Analytics. * Natural rate and forecasts taken from FRBCHI staff estimates.
'14
'16
'18
'20
Time To Take Away The Punch Bowl? “The Federal Reserve’s role is to
take away the punch bowl just as the party gets going” – William McChesney Martin Reasons to remove the punch bowl
only gradually – Uncertainty about whether we are truly at full employment – Inflation has been stubbornly low for a while; let’s not declare victory prematurely – Prudent risk management
Inflation Projected To Hit Target Soon PCE Price Index (12-month percent change)
Core PCE Inflation Oct
Nov
Dec
Monthly
0.1
0.0
0.1
Yr-to-Yr
1.8
1.7
1.7
5 4 Total
3
FOMC Projections* 2 1 Dec-2016
Core 0 -1 -2 2000
'02
'04
'06
'08
'10
'12
'14
'16
'18
Source: Data from the Bureau of Economic Analysis, accessed via Haver Analytics. * FOMC projections are the median values of the FOMC participants’ forecasts for core PCE inflation as reported in the December 14, 2016 Summary of Economic Projections.
9
But We’ve Been Disappointed Before Core PCE Inflation and Projections Over the Years (year-over-year percent change) 2.5 Actual Core PCE Inflation 2012*
2.0
2014*
2016*
Q4-2016 1.5
1.0
0.5 2006
'08
'10
'12
'14
'16
'18
Source: Data from the Bureau of Economic Analysis, accessed via Haver Analytics. * Projections are the median values from the September releases of the Summary of Economic Projections of the Federal Open Market Committee for every other year from 2012 to 2016.
10
Wage Growth Still Somewhat Slow Nominal 12-Month or 4-Qtr Wage Growth (percent) 5
4
Average Hourly Earnings: Production and Nonsupervisory
3
Jan-2017 Q4-2016
2 ECI Compensation
1 2006
'08
'10
'12
Source: Data from the Bureau of Labor Statistics, accessed via Haver Analytics.
'14
'16
11
Workers Reporting Higher Wage Rates 4-Qtr Growth in Average Reported Wage Rate in Current Population Survey (percent) 5
4
3 Average Wage Rate
Adjusted For Compositional Changes
2
Q4-2016
1
0 2006
'08
'10
'12
'14
'16
Source: Data based on Chicago Fed Economic Perspectives paper, “Growth in Work Quality”, by Dan Aaronson and Dan Sullivan. Utilizing CPS data, the average wage rate is predicted using individual characteristics (e.g., education). The adjusted wage rate is the difference between individuals’ actual and predicted wages.
12
Post-Election Financial Developments S&P 500
10 Year Treasury Rate
(Index: Nov. 8, 2016 = 100)
(percent)
120
4
13-Feb-2017
100
3 13-Feb-2017
80
2
60 2013
1 2013
'14
'15
'16
Source: Data from the New York Times, accessed via Haver Analytics.
'17
'14
'15
'16
Source: Data from the U.S. Treasury, accessed via Haver Analytics.
'17
13
Post-Election Financial Developments Broad Trade-Weighted Dollar (Index: Jan-97=100)
CPI Inflation Compensation Embedded in TIPS
130
(percent) 3.0
13-Feb2017 2.5
120
5-10 Year 13-Feb-2017 110
2.0
100
1.5
90 2013
'14
'15
'16
'17
Source: Data from the Board of Governors of the Federal Reserve System, accessed via Haver Analytics.
1.0 2013
'14
'15
'16
'17
Source: Data based on “The U.S. Treasury Curve: 1961 to the Present” and “The TIPS Yield Curve and Inflation Compensation” (Gurkaynak, Sack, and Wright), accessed via Haver Analytics.
14
Inflation Expectations Recovering Survey of Professional Forecasters: CPI Inflation
University of Michigan Median Inflation Expectations
(percent) 2.50
(percent) 3.5 Q1-2017
10 Years Ahead
1 Year Ahead
2.25
3.0 Feb-2016
2.00
2.5 1 Year Ahead
1.75 2013
'14
'15
'16
Source: Data from the Federal Reserve Bank of Philadelphia, accessed via Haver Analytics.
'17
2.0 2013
'14
'15
'16
Source: Data from the University of Michigan Surveys of Consumers.
'17
15
Greater Consumer and Small Business Optimism Indices of Overall Consumer Sentiment
NFIB Optimism and Business Roundtable Indexes
(Michigan: Q1-1966=100; Conference Board: 1985=100)
(NFIB: 1986=100; CEO: 50+ = Expansion) 120
120
90
Feb-2017 Jan-2017
Conference Board Consumer Confidence
130 Jan-2017
110
90
Q4-2016 60
100
30
90
50
Business Roundtable NFIB Optimism
Michigan Consumer Sentiment
0 2006
'08
'10
'12
'14
'16
Source: Data from the University of Michigan Surveys of Consumers and The Conference Board, accessed via Haver Analytics.
80 2006
10
-30
'08
'10
'12
'14
'16
Source: Data from the National Federation of Independent Business and Business Roundtable, accessed via Haver Analytics.
16
Economy Close To Potential By Most Estimates Real and Potential GDP (Bil. Chained 2009 Dollars, SAAR)
16,000
If estimates are correct, fiscal or
other stimulus can only boost GDP temporarily … – And would likely be inflationary … Unless it raises potential
8,000
– Increase available workers – Or make them more productive – Possible, but not easy
4,000 1970 '75 '80 '85 '90 '95 '00 '05 '10 '15 '20 Source: Data from the Bureau of Economic Analysis and the Congressional Budget Office, accessed via Haver Analytics.
Slower Potential GDP Growth Rate CBO Potential Real GDP (Q4/Q4 percentage change) 6
1960-1989 Average
1995-2000 Average
4
2001-2008 Average FRBCHI Estimate
2
2009-2016 Average
0 1960
1968
1976
1984
1992
2000
2008
2016
Source: Data from the Bureau of Economic Analysis and the Congressional Budget Office, accessed via Haver Analytics.
Estimates Of Potential Growth Have Fallen Slower population growth and declining labor force participation
imply slower growth in available workers Slower growth in capital investment and disappointing total
factor productivity growth imply slower labor productivity growth Both could be affected by fiscal and regulatory changes
– But big increases are not easy to achieve Trend Growth In
1995-2000*
2009-2016**
Available Workers
1.2
0.5
Labor Productivity
2.6
0.9
GDP
3.8
1.4
* Source: CBO ** Source: FRBCHI staff estimates
19
Long-term Decline in Labor Force Participation (percent) 68
Fit Using Unemployment Gap*
67
Actual 65 Long-term Trend*
Jan-2017
64
62 1994
'98
'02
'06
Source: Data from the Bureau of Labor Statistics, accessed via Haver Analytics. * FRBCHI staff estimates.
'10
'14
20
Labor Force Participation Participation Rates for Ages 25 to 54 (percent) 100 Men
Women
Jan-2017
75
50
25 1950
'60
'70
'80
'90
Source: Data from the Bureau of Labor Statistics, accessed via Haver Analytics.
'00
'10
21
Productivity Growth Slowed Before Recession Real Output Per Hour (4-qtr annualized percent change) 8
6 1995-2003 4
2
Q4-2016
1948-1972 0 1973-1994
2004-current
-2
-4 1948
'58
'68
'78
'88
Source: Data from the Bureau of Labor Statistics, accessed via Haver Analytics.
'98
'08
22
Lower Equilibrium Real Interest Rates Laubach-Williams Equilibrium Real Fed Funds Rate Estimate (percent) 4
3
2
1 Q3-2016 0 1980
'84
'88
'92
'96
'00
'04
Source: Data from the Bureau of Labor Statistics, accessed via Haver Analytics. * FRBCHI staff estimates.
'08
'12
'16
Appropriate Pace of Policy Firming Federal Funds Rate at Year-End (percent) 5
4
3
2 Market Expectations (Feb. 24, 2017)
1
Market Expectations (Nov. 7, 2016) 0
2017
2018
2019
Long-run
Source: Interest rate projections are from the December 14, 2016 FOMC Summary of Economic Projections. Red dots indicate the median projection. Market expectations are from OIS futures as of Nov. 7, 2016 and Feb. 13, 2017.
Less Room To Cut Rates In Future (percent)
20
16
12
8
4 Jan-2017 0 1980
'85
'90
'95
'00
'05
'10
Source: Data from the Board of Governors of the Federal Reserve System, accessed via Haver Analytics.
'15
Risk Management Considerations Risks for inflation forecast weighted to downside Policy options asymmetric
– Little room to loosen conventional policy to counter downside shocks – Ample room to tighten policy if inflationary pressures rise too much Risk management thus prescribes accommodative policy
– Counter risk of inflation expectations becoming entrenched below target – Provide a buffer against possible future downside shocks that might otherwise drive us back to ZLB