Charles Evans
The Puzzle of Low Inflation
25/09/2017
The consumer
sector has been the main driver of growth, and it
should continue to play this role.A big part of the strong consumer
story is the labor market.
We
understand that consumer sector is very important in the explaining growth of
USA. I think all of the FED analysis is based on this story.
Ok.
Turn the radio to the why we expect inflation to get back to 2 percent.
Firstly,
Evans explained factors which affect inflation.
Inflation
can be explained by three elements:
1)
Temporary cost factors,
2)
Resource pressure,
3)
Inflation expectations.
1)
Temporary cost factors:
a- Stronger dollar
b- Import prices declines
c- Idiosyncratic shift declines
A stronger
dollar and associated declines in import prices played
a large role in reducing inflation at various times over the past nine
years.But the stronger dollar is not a factor holding back inflation today:
The dollar was relatively stable through most of 2015 and 2016, and then
has depreciated against most currencies so far this year. However,
temporary idiosyncratic declines in the prices of certain goods and
services earlier this year—such as cell phone plans and prescription drugs—might other
a partial explanation for the low inflation readings since spring.
2)
Resource pressure:
Tight
resource constraints put upward pressure on costs and lead to increases in
prices.When the labor market is tight, the unemployment rate is below
the natural rate and wages and prices tend to rise.
Tight labor market means that
unemployment rate
< natural unemployment rate
prices tend to rise
Slack labor markets are characterized by an unemployment
rate that exceeds the natural rate and correspondingly weaker wages
and prices.
Slack (Loose) labor market means
that
unemployment rate
> natural unemployment rate
prices tend to decrease.
Throughout
most of the recovery, the unemployment rate far exceeded its estimated
natural rate, and so resource slack offered a reasonable partial
explanation for low inflation readings. However, by most metrics, we are
at or very near full employment today. Therefore, with resource slack
close to zero, it’s generally a neutral factor for the current inflation rate.
According
to the standard paradigm, we should see some upward pressures on wages and
inflation. How much can we expect?
In
my view, they will be modest—tighter labor markets will contribute to a gradual
increase in wage and price pressures, but not an outsized increase in
inflation. First, I do not foresee a large
undershooting
of the natural rate, so that the pressure on resources will not be too great.
Second,
statistical evidence indicates that the linkage between unemployment and
inflation is not as powerful today as it was in earlier times. In other
words, any given amount of labor market
slack
today plays a smaller role in generating inflation than it did, say, in the
1970s or 1980s.
Instead,
I am more concerned about our ability to get inflation back up to target within
a reasonable period. One reason is, as I mentioned, the natural rate is
difficult to measure and changes over time. So, it is possible that there
is actually greater slack in labor markets than we currently estimate.
3)
Inflation expectations:
Treasury
Inflation-Protected Securities (TIPS), and survey measures from households—suggest
inflation expectations are low.
When
Mr . Evans finish his statements about declining inflation, he emphasizes low
productivity growth and slow wage growth relationship.
Slow
wage growth is, in part, due to the low
productivity growth in recent years. However, it also likely
reflects expectations for low inflation. For instance, imagine that an employee
in your firm increases the value of your products in real terms by 1
percent and that you both expect inflation to be only 1-1/2 percent. Well,
2-1/2 percent would seem to be a fair increase in wages for that worker.
If you both thought inflation would be 2 percent, then you’d probably end up at
a 3 percent wage hike.
Mr
. Evans' statements about FED policy approach in 2017 and later
We
plan for balance sheet normalization to be essentially
on autopilot, adjusting the stance of monetary policy
primarily with the federal funds rate.
Looking ahead
at the future path for the funds rate, given my current outlook, I
am broadly comfortable with the projections associated with the median
SEP, which see the rate rising to 2.7 by the end
of 2019.
Dr. Engin YILMAZ
29.09.2017
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