U.S. Deflation Risk Seen Growing in Wells Fargo ModelSimon Kennedy
The U.S. economy may prove more prone to deflation than the Federal Reserve acknowledges and that may present a reason to keep monetary policy loose, according to a model created by Wells Fargo Securities LLC.
Deflationary pressures have been “relatively high” since January 2010 and now have a 66 percent chance of prevailing in the U.S., according to Charlotte, North Carolina-based economists John Silvia, Azhar Iqbal and Blaire Zachary. Their calculations include factors such as the personal consumption expenditures price deflator, unemployment rate and the Fed’s inflation target.
The model is “useful for policy makers, investors and consumers who can attach a probability with each more-likely scenario of future price trends: inflationary, deflationary or price stability,” the economists said in a Feb. 17 report.
They say that such a persistently higher probability can highlight a looming threat. In the 1980s, for example, the model would have pointed to the risks of higher inflation, which did mark that decade.
“The recent year’s surge in the deflationary pressure probabilities may offer a justification for the highly accommodative monetary policy,” the authors said in the report.
The Wells Fargo model is more worrying than one created by the Federal Reserve Bank of Atlanta, which is based on the market for Treasury inflation-protected securities. As of Feb. 14, that gauge said the probability of deflation was steady at zero.
Central bankers so far don’t sound worried by a deflation threat. Fed Chair Janet Yellen told lawmakers on Feb. 11 that some of the recent softness in prices “reflects factors that seem likely to prove transitory.”
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Robots aren’t coming to the rescue of the U.S. economy.
In a paper titled “The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections,” Robert Gordon of Northwestern University revisited 2012 research that triggered a debate on the outlook for economic growth by declaring the U.S.’s best 250 years are behind it.
The new work focuses on rebutting those he calls “techno-optimists,” among them Erik Brynjolfsson of Massachusetts Institute of Technology. They argue technology may be at another inflection point which will help power an economic expansion. Gordon still thinks growth is at risk due to poor demographics, low educational attainment, rising government debt and inequality.
In the paper he repeats that average annual economic growth will slow to 0.9 percent per capita in the 25 to 40 years after 2007, from 2 percent in the 116 years before that. He says innovation is faltering just as it did in the 1970s, when technological advancement started coming from improvements in existing products rather than new breakthroughs. For him, Apple Inc.’s iPad is a reworking of previous developments in computing, not a reason for confidence in innovation.
Each field the optimists cite is addressed by Gordon. Approvals of major drugs have declined over the past decade, robots are limited to narrow tasks rather than multi-tasking and 3-D printing lacks the economies of scale and efficiency of an assembly line, he says in the paper published this week by the National Bureau of Economic Research.
As for big data -- the term given to the vast quantity of information amassed by businesses, governments and universities that requires powerful computers for storage and analysis -- Gordon says it is a zero-sum game. It is typically used by companies such as airlines to find ways of luring consumers from rivals rather than delivering new economic advantages.
Meantime, driverless cars offer “benefits that are so minor compared to the invention of the car itself,” he said.
“There is a strong case that technological change is slowing down, not speeding up,” Gordon wrote. He noted that in the 41 years since 1972, productivity growth was 0.77 percentage point slower than in the prior 81 years.
In what he calls his “most radical thought,” Evanston, Illinois-based Gordon said the U.S. may be about to be eclipsed as other countries with fewer weaknesses, such as Norway and Switzerland, take advantage of its inventions.
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The U.S. and European labor markets may be closer than would appear from unemployment rates.
While the U.S. jobless level of 6.6 percent is almost half the euro area’s 12 percent, economists at Credit Suisse Group AG argue in a Feb. 14 report that the differences are less extreme.
The reason for the divergence is differing labor participation rates. They have been closing over the past two decades, with the U.S.’s falling and Europe’s rising. Labor-force participation -- the share of working-age people either holding a job or looking for one -- often declines in periods of economic weakness as people give up hunting for jobs.
“Keeping participation rates unchanged at their pre-crisis level, the euro area unemployment rate is at the same level as in the U.S.,” the economists said.
Europe’s participation rate should continue to rise given better health conditions and government laws aimed at keeping older workers employed. Recent initiatives to boost youth employability should counteract the decline in that cohort, they said.
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Fed economists are still better than their private-sector peers in predicting the outlook.
In an update of a 2000 paper by Christina Romer and David Romer, economists Makram El-Shagi of California State University-Long Beach, Sebastian Giesen of the Bundesbank and the European Central Bank’s Alexander Jung looked at the recent forecasting record of the Fed’s staff.
They found that the central bank economists had a “significant information advantage” in making forecasts from 1968 to 2006, attributing that to the staff’s access to better insight on the path of interest rates. Other tests showed the staff is also better when there is an increase in economic uncertainty, they said.
The study was published Feb. 18 by the ECB.
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The young are driving the rebound in U.S. borrowing, according to the Federal Reserve Bank of New York.
Aggregate consumer debt increased by $241 billion in the final quarter of 2013, the largest quarterly rise since 2007, data showed Feb 18.
In a breakdown of the data, New York Fed economists found that for mortgages, auto and student loans, increases in balances between the fourth quarters of 2012 and 2013 were driven by those less than 30 years of age. Those between 30 and 39 took out the most mortgage loans.
While auto and student loans have grown for some time, there was also a pickup in credit card and mortgage debt among the young.
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U.S. policy makers should perhaps be careful what they wish for in hoping for a surge in economic growth, according to the Milken Institute.
That’s because equity investors may not be well positioned for a jump in economic activity that could force the Fed to tighten monetary policy, which in turn would push up bond yields. Corporate profit margins could also be squeezed as wages gain, Keith Savard, an economist at the Santa Monica, California-based institute, said in a report this week.
While such a scenario isn’t the view of most investors and economists, Savard said, few expected the Fed to raise interest rates in early 1988 or 2003. Stock markets can also decline when economic growth is robust, as happened in 1987, 1994 and 1998, he said.
“Managing the effects of economic growth will be a more daunting task than policy officials would have us believe,” said Savard, a former Fed economist.