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  • Writer's pictureStephen H Akin

Fly Fishing with the Fed

Updated: Aug 20, 2021

The Kansas City Federal Reserve Boards annual symposium held each year in Jackson Hole, Wyoming will be August 26 to 28, 2021.

As an insight into the thoughts of Esther L. George President and Chief Executive Officer Federal Reserve Bank of Kansas City

Let's take a look at some highlights of her recent speech of August 11, 2021. For the full text of her speech please visit this link.

18th Annual Economic Measurement Seminar National Association for Business Economics Remarks delivered virtually

The views expressed by the author are her own and do not necessarily reflect those of the Federal Reserve System, its governors, officers or representatives.

Is the Economy Tight or Slack?

Thank you for inviting me to participate in this year’s Economic Measurement Seminar. As you well know, measurement and data are central to monetary policy making. Data are the vocabulary that policymakers use to build the narratives that are essential for making sense of the economy and for explaining policy decisions. Data alone cannot tell the story, but the story certainly depends on data. Consequently, the same data can often underpin widely divergent economic narratives. As a policymaker, those narratives are shaped not only by an assessment of the data, but also by experiences. Wisdom and the humility to adjust a narrative is essential, especially when the data make the story increasingly difficult to tell.

Today I would like to look at the data and narratives as they relate to a particular question with important implications for monetary policy: Is the economy tight or slack? The strength of demand and the ability of supply to meet that demand have been significantly impacted by the pandemic and the related policy response. As I talk to contacts in the Kansas City Fed’s region, I often hear anecdotes that suggest an economy that has run into constraints, including reports of the difficulty in finding workers and of having to pay much higher prices for materials and transportation. These stories are confirmed by the data, with a record number of unfilled job openings and sharply higher prices for many commodities. At the same time, almost 6 million fewer individuals are working now relative to before the pandemic. This suggests that there remains considerable slack in the labor market.

So, is the economy tight or slack? Prices are telling in making this assessment. An economy operating near or at its productive capacity is likely to display higher prices. On the other hand, slack implies under-utilized resources, such that higher demand can be met without increased prices.

This narrative for why the current supply and demand constraints might be expected to ease over time strikes me as a reasonable baseline. My own expectation is that growth will step down but remain robust; that the labor market will continue to recover at a rapid pace; and that inflation will moderate. But this narrative would be incomplete without acknowledging the risks around these assumptions.

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Importantly, the effects be as pronounced on the supply side as the demand side, prolonging the tightness of the economy and maintaining upward pressure on prices. Renewed concern over the virus could impede the recovery in services consumption such that demand remains directed towards sectors of the economy that are near capacity and away from those sectors that have available slack. The surge in the virus could also delay the normalization of the labor market, particularly if schooling and childcare is once again disrupted. The spread of the variant has been particularly disruptive in Asia, where vaccination rates remain quite low. Given Asia’s large imprint in global value chains, disruptions in the manufacturing sector there can spill over quickly to other parts of the world, further exacerbating production bottlenecks and shortages, and inflation pressure.

Aside from the economic threats associated with the Delta variant, the assumption that demand will moderate may prove otherwise given the high level of household savings. In particular, a considerable portion of the stimulus transfers to households have been saved, with estimates suggesting that the stockpile of household saving has increased by close to $2.5 trillion. Of course, healthy household balance sheets are positive for the economy, and to the degree that the saving is spent out over time, this could support strong and steady growth for some time. However, if households instead choose to spend rapidly, a burst of demand could keep the economy at capacity, reinforcing bottlenecks and putting continued upward pressure on prices. Households have a lot of firepower, and if and how quickly they choose to spend will be an important factor in how tight the economy remains.

The outlook for monetary policy What does this mean for monetary policy and the Federal Open Market Committee’s long-run objectives for the economy? How should policymakers account for today’s “tight” demand and supply dynamics in their decisions about the path of asset purchases and interest rates? Since last December, the Committee has stated that it expects to keep the policy rate near zero until the labor market has reached levels consistent with maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. The FOMC also expects to maintain its purchases of Treasuries and mortgage-backed securities

until substantial further progress is made toward these employment and inflation goals.

Without question, the combination of fiscal and monetary policy supports at the onset of the pandemic bridged the economy’s transition from a deep contraction to a robust rebound. Now, with the recovery underway, a transition from extraordinary monetary policy accommodation to more neutral settings must follow. Today’s tight economy as I described earlier certainly does not call for a tight monetary policy, but it does signal that the time has come to dial back the settings. With year-over-year inflation running well over the Committee’s target and steady progress in monthly employment gains, the FOMC’s long-run objectives for price stability and employment are in focus. While recognizing that special factors account for much of the current spike in inflation, the expectation of continued strong demand, a recovering labor market, and firm inflation expectations are consistent, in my view, with the Committee’s guidance regarding substantial further progress toward its objectives. I support bringing asset purchases to an end under these conditions.

As this adjustment gets underway, public attention will naturally turn to timing for adjusting the policy rate, though it is important to note the timing of the tapering of asset purchases is not mechanically connected to the timing of any policy rate adjustment. With both upside and downside risks in play, and multiple policy tools in use, judging the achievement of criteria for raising rates is more complicated. One might argue that today’s inflation dynamics are likely to keep inflation moderately above 2 percent for some time and align with the Committee’s threshold criteria. On the other hand, the criteria for judging maximum employment are murkier.

While it is clear that we remain far from the historic low levels of unemployment achieved pre-pandemic, it is less clear to me that such a benchmark will be the best guidepost in the current expansion. The pandemic introduced a number of frictions into the labor market, many of which are likely to evolve over time. Barring further intensification of the virus, I would expect these frictions to fade, promoting strong job gains and a relatively fast approach to maximum employment. However, the experiences of the past year may well have resulted in a number of structural changes to the labor market, including how, when, and where people work. These changes could affect the assessment of maximum employment in ways that are not yet clear.

As witnessed during the last expansion, it can take some time to draw individuals back into the labor market. This is not an argument for keeping rates unchanged but ensuring accommodation adjusts as the economy expands, avoiding imbalances and instability that can derail such gains.

Needless to say, the road ahead to policy normalization is likely to be a long and bumpy one as we navigate inflation and labor market dynamics in the post-pandemic economy. Considering the financial stability landscape also will be key to the achievement of our goals. Along the way, a careful assessment of the data will be essential in shaping the narratives that guide policy decisions, balancing nimbleness and patience and steering clear of policy errors.

Another press release from the Fed this week was minutes on monetary policy.

The highlights:

The path of the economy continues to depend on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‐term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.

Last December, the Committee indicated that it would continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‐backed securities by at least $40 billion per month until substantial further progress has been made toward its maximum employment and price stability goals.

Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

The full text and be found at this link:

In closing this post I would like to thank the Financial Planning Association of Mississippi.

They hosted a wonderful luncheon at the River Hills Country Club this week. The Speaker was Mississippi Secretary of State Michael Watson.

Secretary Watson gave both an informative and entertaining presentation that was enjoyed by all!

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