The Outlook and Current Policy Challenges

NAHEFFA Spring Conference

May 7, 2018

Jeff Fuhrer

EVP and Senior Policy Advisor

Federal Reserve Bank of Boston

1

2

Disclaimer: The views represented in

this presentation are solely those of

the author, and do not reflect the

views of the Federal Reserve Bank

of Boston, the Board of Governors

of the Federal Reserve System, or

the Federal Open Market Committee

Labor market strength continues

Spending data a bit weaker for the first quarter Slower consumption

growth, but moderate investment spending

Still, the underpinnings for growth are good Income, wealth, financial

conditions, tax cuts, federal spending, ROW growth

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2016:Jan 2016:Jul 2017:Jan 2017:Jul 2018:Jan

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Employment growth

Sustainable growth rate (rate of entry into labor force)

Sources: Bureau of Labor Statistics (employment), Bureau of Economic Analysis (GDP), author’s calculations, Haver Analytics

0.0

1.0

2.0

3.0

4.0

2017 2018:Q1

Contributions to GDP growth

Consumer spending

Investment spending

Residential investment

Net exports

Inventory accumulation

Income, wealth, financial conditions are still supporting Sentiment

highest since 2004

Fiscal policy: both tax cuts and increased federal spending boost GDP

ROW growth improved, but flattening

4

0.8

1.0

1.2

1.4

1.6

1.8

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2009:Q2 2010:Q4 2012:Q2 2013:Q4 2015:Q2 2016:Q4 2018:Q2

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Household income and wealthHousehold wealth

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HH income (inflation-adjusted)Apr

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Financial conditions: accommodativeStock prices10-year Treasury yieldExchange value of the dollar

Sources: Flow of Funds (wealth), BEA (income), Wall

Street Journal (stock prices), Federal Reserve (Treasury

yield, exchange rate), Haver Analytics

Now approximately at

our 2% goal

Earlier, temporary

factors held down

inflation

Those have faded

Core inflation (PCE)

currently at 1.9% for

past 12 months

2.25% for past 6

months, annualized

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0.5

1

1.5

2

2.5

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Core inflation trends, PCE

3-month

6-month

12-month

Source: BEA (PCE inflation), Haver Analytics

Above-trend growth For 2018, 2019

At or a bit below trend in 2020?

Falling unemployment To the mid-3’s?

Gradually rising inflation Near 2% this year (by Q4)

A bit higher later on

All conditioned on gradually rising interest rates

6

0

1

2

3

4 GDP growthRange of submissions

4-qtr. GDP growth

2

3

4

5

6 Unemployment

Range of submissions

Unemployment rate

Forecast

Sources: BEA (GDP), BLS (unemployment), Summary of Economic Projections (Board of Governors), Haver Analytics

Forecast

Old news: Aluminum, steel (<2% of imports)

New news: Exemptions from steel, aluminum tariffs for allies

Newer news: US tariffs on Chinese imported goods—IP related? No details yet.

Newest news: China pre-emptively raising tariffs on imports from US (mostly agricultural)

Fast-changing; mostly small changes; hard to gauge net impact

7Sources: Bureau of the Census (trade data), Haver Analytics

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Total Chinese

imports = $524B

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China EU

Trade factsTrade Balance Imports

Average growth = 2.2%

Slow by historical standards

Yet it produced a dramatic drop in unemployment

Why so slow? Productivity growth has

been slow

Labor force growth slow

Thus “potential” or sustainable growth has been slow

Probably will be for a while

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-4

-3

-2

-1

0

1

2

3

4

5

GDP growth

Productivity growth, 5-year

Unemployment rate (right)

Avg. for this

recovery

Avg. for post-1960s

recoveries

Sources: BEA (GDP growth), BLS (Productivity growth, unemployment rate), Haver Analytics

Our responsibilities, as delegated to us by Congress: The “Dual Mandate”: low inflation, maximum (sustainable)

employment

Where are we in achieving these goals? First, employment:

Sources: Bureau of Labor Statistics (unemployment, employment, AHE wage growth, nonfarm compensation), Haver Analytics 9

7.6

8.1

8.6

9.1

9.6

10.1

3.8

4.0

4.2

4.4

4.6

4.8

5.0

5.2

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2016:J

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Measures of labor market slack

Civilian unemployment rate

"U-6" (broader measure of unemployment (right scale))

Estimates

of long-run

sustainable rate

You saw this chart before

What’s our goal? 2%

How close are we? Pretty darned close

Dip below 2% appears to have been temporary

If unemployment dips well below 4%, will nothing happen?

Expect gradual rise to 2% and a bit above

Sources: Bureau of Economic Analysis, Haver Analytics 10

0

0.5

1

1.5

2

2.5

3

2016:J

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2016:S

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2017:J

an2017:M

ar2017:M

ay2017:J

ul

2017:S

ep2017:N

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2018:J

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ar

Core inflation trends, PCE

3-month

6-month

12-month

11Source: Summary of Economic Projections, 9/20/17, Federal Reserve Board, CME Group FedWatch tool

http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/

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June September December

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FOMC meeting, 2018

Financial market assessments of future Fed policy (4/30/18)

1.75-2%3 increases or more this year4 increases or more this yearMore than 4

3-4

0

1

2

3

4

5

2014 2015 2016 2018(March)

As of December FOMC meeting in year indicated, except for March 2018

Fed’s predictions of rate increases versus reality

Number of increases expected innext calendar yearActual (next year)

Low rates imply falling unemployment

In every episode post WW II, unemployment slipping too far below normal leads to a recession—and/or financial upheaval

We’d prefer a stable, sustained recovery

-4.0

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11987:Q

31991:Q

11994:Q

31998:Q

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32005:Q

12008:Q

32012:Q

12015:Q

3

Difference between unemployment rate and natural rate

Sources: Bureau of Labor Statistics (unemployment rate), Congressional Budget Office (natural rate of unemployment), Haver Analytics12

The idea: How much room do monetary and fiscal policy have to operate?

i.e. How much capacity to stabilize the economy in the event of a recession?

What to do about these constraints?

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Publicly-held debt to GDP ratio, with CBO projections Projection

-6-5-4-3-2-10

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29Months

Monetary policy “cushion”

Median decline in funds rate, 1960-2008SEP long-run funds rate (inverted)

Sources: CBO (debt projections), Wall Street Journal (funds rate), Board of Governors (SEP long-run rate), Haver analytics

Fiscal policy

Up to Congress

Given near-certain and

immediate increases in

Medicare and Social Security

expenses, sooner is better

Monetary policy

Raise the inflation goal

(increase “cushion”)

Adopt a flexible inflation goal

(likewise)

Use QE?

14

0

1

2

3

4

5

Year 0 Year 1 Year 2 Year 3 Year 4

Using the policy cushion (0.5% real rate)

4% inflation goal

3%

2%

Sources: CBO (outlays), author’s calculations.

Change at the top

What does it mean? Mostly, continuity, on

Monetary Policy, and

Regulation

Other openings Vice Chairman of the Board of Governors (Clarida,

new!)

Three other Governor slots (one community banker nominated!)

President of the NY Fed (Williams, new!)

15

Janet YellenJay Powell