February 27, 2015

Two big questions By CFEGuru

By Bob Barbera and Jon Faust

Simple plots of recent GDP and inflation data highlight two profoundly important questions facing monetary policymakers in the United States. GDP is at a level several percentage points below reasonable estimates of its pre-crisis trajectory (Fig. 1):[1] Will we ever regain that lost output? Inflation had run well below the Fed’s objective for the two years prior to the recent plunge (Fig. 2):[2] Will inflation bounce back, all the way back, to the Fed’s target? (more…)

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February 16, 2015

Jobs, inflation, and growth in 2015 By Bob Barbera

Recent readings for the U.S. economy are filled with contradictions. Non-farm payroll gains were quite strong. Unemployment fell to 5.7% from 6.1%, last September. Nonetheless, real GDP growth was soft, up only 2.6%. And retail sales were quite weak. Reconciling robust gains for employee hours and a low jobless rate with tepid increases for real GDP and soft nominal spending gains is very difficult.

The most recent Survey of Professional Forecasters suggests that forecasters generally reconciled these contradictions by doing the following:

Assume a nearly instantaneous sharp slowdown for job growth.
Project a modest additional decline for unemployment.
Assume a continuation of unprecedented weakness for labor productivity growth.
Project a modest pace of advance for real GDP.
Assume almost no change for core inflation.

Specifically, for 2015 the recent survey has:

Non-farm payroll gains average 238,000/month. This compares to the 336,000 average monthly gains of the past 3 months, the 282,000 average monthly gains of the past 6 months, and the 267,000 average monthly gains of the past 12 months.

Unemployment falls to 5.2% in Q4:2015 By sharply curtailing the pace of job growth, over the four quarters of 2015, forecasters avoided writing down projections that took unemployment below 5%. They also avoided projecting a rebound for the participation rate.

Labor productivity rises by a tepid 0.8% Notwithstanding the slower pace for job growth, that growth would still suggest a gain for employee hours of roughly 2%. A traditional projection for labor productivity, say a gain of 1.8%, would require forecasters to embrace hefty gains for real GDP. Instead, labor productivity gains are consigned to rise by less than 1%.

Real GDP climbs by 2.8% Embracing evidence of soft nominal consumer spending trajectories, and acknowledging the likely drag on output that trade will deliver, real GDP growth is projected to approximate the pace registered in Q4:2014, a pace well short of the gains witnessed in Q2:2014 and Q3:2014.

Core inflation is projected to remain steady, rising 1.7% in 2015. All forecasters know that gasoline prices have plunged and that headline inflation will fall for a few months, simply a consequence of petroleum product price declines. Beyond that, however, the consensus forecast looks for little change, anticipating a 1.3% rise in core inflation in Q1:2015, followed by a 1.8% rate of inflation for the remainder of the year.

What is the most striking aspect of the consensus view? Almost to a person, forecasters felt compelled to sharply rein in jobs growth. The current recovery reminds us that one should never doubt dire predictions, but where is the evidence for a sharp deceleration? Should this really be the modal forecast? Plunging petroleum prices, history makes fairly clear, act as a stimulus in the U.S. It is true that the rise for the dollar and the fade for economic growth in Europe, Japan and China all combine to suggest that trade will be a drag on real growth in 2015. That said, netting out the effects of rest-of-world weakness against a halving of the U.S. consumer energy bill, probably suggests a small positive change in U.S. economic momentum.

I suspect that the projected, sharp job market retrenchment is not due to signs of weakness. Instead, I suspect it is because of the forecasting havoc that continued strong job growth would bring to the rest of the forecast.

Some simple arithmetic

Suppose job growth does not slow, and instead climbs at the average pace in place over the past 3 months? Suppose further that labor force participation is stable, as it was over the four quarters of 2014. The jobless rate, in such circumstances falls to 4.1%. In addition, total hours worked will have climbed at a 2.7% pace. With all that, one would be forced to forecast a rise for real GDP of nearly 4%, even if one embraces the notion of a tepid, less than 1% climb for labor productivity.

How can we invent a climb for real GDP of nearly 4%, amid tame nominal spending trajectories and stable core inflation? That’s simple. We can’t.

Suppose instead that we temper our enthusiasm for job strength and we embrace the trajectory in place over the past 6 months. And, once again, let’s assume an extension of a stable participation rate. In this case, Unemployment, Q4:2015, averages 4.5%. And we still need to contrive a story that allows for real GDP growth of around 3.5%, amid soft spending trajectories and core inflation a bit below 2%. Again, a very tough story to cobble together.

This daunting accounting, I suspect, helps explain the willingness to envision a violent job growth downshift. Accepting recent jobs trajectories boxes you into other storylines that you are not ready to tell. Jettison the jobs strength and it is much easier to roll out consensus views for much of the rest of your forecast.

Thinking inside the box

Is there any way to keep the jobs strength and tell a plausible economy wide story while remaining boxed in by the confusing configuration of recent data? One way to do so requires us to make two leaps. Bet on a major fall for core inflation. And assert that labor force participation, at long, long last, is now on the rise. Second things first. Over the 7 years through Q4:2013, the participation rate fell at a 0.8% per year pace. What happens if it rises by 0.8% in 2015? Put the rate at 63.3% and the jobless rate averages 5% in Q4:2015, even with monthly job gains running at 330,000 throughout the year. Throttle back the job growth assumption to the six month trajectory and what happens? A year of 280,000 per month job gains ends with the jobless rate at 5.3%. What about output growth? January’s import price data may give us the key. Core prices fell sharply, by 0.6%, month-on-month. They were down 1.1% year-on-year. Moreover the data show a clear acceleration on the downside. This is all too easy to explain. There is always an echo effect in other prices, when energy prices plunge. We also have a 15% rise for the U.S. dollar versus a very wide basket of U.S. trading partners’ currencies. Lastly all indications suggest that inflation in China is in sharp retreat. This suggests prices of goods sent from China could fade this year. Suppose the consensus assumption about core inflation is wrong? If core inflation falls to 0.7%, we have a percentage point of additional real growth, for any given level of nominal spending growth. We can, therefore, assert the following. Real GDP growth of 3.5% to 4% is achievable without a material acceleration for spending, if core inflation fades in 2015. Furthermore, in this scenario, the jobless rate can end the year a bit above 5%, notwithstanding strong gains for monthly payrolls. We simply need to embrace the notion of a bit of bounce back in the participation rate, after 7 very lean years. What about tepid productivity? We get labor productivity up to 1.5% in a world of 280,000 per month job gains and 4% real GDP. Not an impressive number. But one that does not conjure up bleak stories of continued malaise in the aftermath of the Great Recession.

The CFE forecast

In broad terms, the story just given explains what our forecasting team here at the CFE submitted to the Survey of Professional Forecasters. Let’s be clear, like the other forecasters, we are sometimes right in key features of our forecast, always wrong somewhere, and occasionally wrong in general. One of the most important reasons for making a forecast, however, is that it forces one to devise a story that most plausibly reconciles all the available data. With the current confusing constellation of data, this is really making a story that is least implausible. Most forecasters seem to have concentrated the implausible part mainly on job growth. We have spread it around a bit more in a way that we think is worth considering.

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December 26, 2014

Capital controls for Russia? By CFEGuru

“The main lesson from international experience is that controls on capital outflows can work—but only if they are associated with a credible policy plan addressing the underlying cause of the confidence crisis.”

Olivier Jeanne, of the Center and Peterson Institute, has an interesting op-ed in the Dec. 23 Financial Times arguing that capital controls may be useful policy tool for Russia at present, so long as they are used only to provide breathing space to begin putting in place more fundamental policy changes.

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December 18, 2014

Patience and prices By Bob Barbera

Consensus expectations were off regarding the November estimate for U.S. CPI inflation released yesterday. The 0.3% fall for headline inflation was a larger drop than estimated by 82 of the 84 economists who ventured forth with an opinion in Bloomberg’s survey. No-one offered up a forecast of a greater fall than 0.3%. We suspect that consensus expectations for inflation in early 2015 are similarly off the mark. Back-of-the-envelope calculations suggest that for a relatively wide range of oil price scenarios, over the next several months, the U.S. headline inflation rate will plunge.

If we embed today’s energy futures prices into consumer product prices, the drop in first quarter 2015 CPI inflation could be breathtaking.

A plunge for headline inflation is already baked in the cake for December. The E.I.A. surveys of gasoline prices at the pump December-to-date are down around 70 cents, year-on-year. That is almost double the 32 cent year-on-year fall registered in November. Based on the energy component alone, the CPI headline looks set up to fall around 0.7% for the month, which would take year-on-year headline inflation down to 0.3%. And it appears there is more to come. If we embed today’s energy futures prices into consumer product prices, the drop in first quarter 2015 CPI inflation could be breathtaking. For example, near-contract futures prices for gasoline are trading down $1.15, year-on-year. (more…)

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December 16, 2014

Of dots and (considerable) periods By Jon Faust

In a recent post, I argued that the Bernanke and Yellen Fed’s have been striving for a ‘no tea leaves’ approach to policy communications. An astute JHU student responded, ‘How about those dots?’ Good students can be annoying that way.

There is a sound reason for publishing the dot plot, but we should not expect these ‘if you were Czar’ policy paths to be of much value in clarifying policy intentions of the FOMC.

At the outset, let me remove some suspense by sharing what Wednesday’s new dot plot will clarify about the likely path of policy: nothing.

What is the dot plot? The FOMC publishes a Survey of Economic Projections (SEP) quarterly, giving the 19 FOMC participants’ projections for real activity and inflation.[1] Along with these projections, each participant submits his/her view of where the federal funds rate will be at the end of the current year and end of the next couple years. These year-end rates for the participants are then turned into the dot plot—the October plot is below. (more…)

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December 6, 2014

What do markets expect the Fed to do? By Jon Faust

Matt Raskin, along with several co-authors (Richard Crump, Emanuel Moench, William O’Boyle, Carlo Rosa, and Lisa Stowe), has published a series on measuring policy interest rate expecations on the NY Fed’s Liberty Street Economic Blog.

These blog posts provide an excellent discussion of how to interpret market and survey-based indicators of interest rate expectations. For example, the authors note, “Market prices provide timely information on policy expectations. But as we emphasized in our previous post, they can deviate from investors’ expectations of the most likely path because they embed risk premiums…”

By the way, Matt Raskin recently returned to Hopkins to complete his PhD after leaving a few years ago to work at the New York Fed. He is now an Assistant Vice President in the Markets Group, and I can attest that Matt’s analysis played an important role in policy discussions on a number of occasions over my recent time at the Fed.

Good work by Matt and his co-authors.

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November 21, 2014

Today’s CPI release: If you just squint, you’ll see … By Jon Faust

By Bob Barbera and Jon Faust

The FOMC minutes released yesterday and today’s CPI data release underscore a remarkable shift. Over the past five years, the state of the labor market has dominated monetary policy discussions, but for the first time since the crisis inflation is now taking center stage. All through the recovery, of course, inflation hawks have warned that inflation would soon demand our attention. But probably neither hawks nor doves predicted that excessively low inflation would be our concern as unemployment moved closer to normal. And yet today’s CPI data and the FOMC commentary reported yesterday remind us that, in the short run, inflation is probably headed lower.

Today and in coming months, analysts at the Fed and elsewhere will be parsing the data and squinting extra hard to see signs that inflation will, without additional policy measures, move back up to desired levels. The difficulty, of course, is that factors such as the falling price of oil and of other commodities and the rising value of the dollar are putting downward pressure on inflation.1 A centerpiece of inflation analysis in situations like this is examining the behavior of sub-components of inflation that are less likely to be affected by transitory forces. These indices, one hopes, will give a clearer sense of where a shadowy beast known as underlying inflation may be headed. The baseline view of many analysts is that underlying inflation is headed slowly back to the Fed’s objective. This may be the right baseline, but recent data have, in our view, significantly eroded the confidence we can have in this baseline view.


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November 8, 2014

Hawks, Doves, and Tea Leaves By Jon Faust

In its most recent policy statement, the FOMC removed the phrase, “there remains significant underutilization of labor resources” and substituted that the “underutilization of labor resources is gradually diminishing.” Fed watchers have pronounced this hawkish. I have a different reading, resting on my perception of two recent changes I perceive in Fed communications.

Having been involved in the crafting of FOMC statements over the last few years, I believe that small wording changes really do mean something, but small changes tend to mean small things.

First, I believe that the Fed now strives for “no tea leaves” approach to communication. The FOMC declares in its strategy document that it “seeks to explain its monetary policy decisions to the public as clearly as possible.” This is a dramatic change from the situation not so long ago, when speaking about the future course of policy was viewed, both inside the Fed and by most central banks, as a mortal sin. The transparency revolution began tentatively decades ago, with the FOMC offering occasional terse hints about policy. Interested observers justifiably gazed at the few words offered up like so many tea leaves, seeking to divine the future course of policy. Expertise in this form of divination was much prized on Wall Street.

Expert analysts still pour over the FOMC statement, making much of every change. But I think (more…)

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November 7, 2014

Nice weather we’re having? Seasons and jobs By Jon Faust

When macroeconomic data such as today’s employment report are released, we often focus on seasonally adjusted numbers.  Seasonally adjusted employment numbers smooth through changes in employment that are judged to be part of some annual cycle such as the jump in retail employment every year as the Christmas buying season ramps up.  Of course, there is no magic wand that allows the Bureau of Labor Statistics to turn the raw numbers into numbers that leave out seasonal effects.  In recent research, Jonathan Wright has argued for a change in the way that the jobs data are adjusted.  He argues for a methods that would tend to deliver a less volatile estimate of the importance of seasons. In a blog post at Brookings.edu the implications of this research for Friday’s jobs report are discussed. Justin Wolfers also discusses Jonathan’s work in the New York Times.  Have a look, and enjoy the nice fall weather.

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October 28, 2014

A Farewell to QE? By Jon Faust

The FOMC has long communicated that, if something like its modal outlook played out, it would likely make one final $15 billion reduction in the pace of asset purchases at its October FOMC meeting, which is now taking place.  This would put an end to the purchase program known as QE-infinity.  In essence, we may be coming to the “beyond” stage of the Fed’s bold September 2013 declaration of “To QE infinity and beyond.”

Most analysts seem to see the end of the program at this meeting as a foregone conclusion, and in this view the main discussion at the meeting will be about how to change the forward guidance for the federal funds rate—guidance that is currently intertwined with purchase program.  Given the momentous effects often attributed to QE, however, I thought it would be worth setting aside the forward guidance issue for a moment and considering a few farewell questions regarding QE.


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