Yellen Legacy-to-Date Sparkles on Jobs But Stumbles on InflationBy
Reduced labor force slack expected to lift wages over time
Fed officials begin to warn that rate path could change
On the employment side of the Federal Reserve’s twin objectives, Chair Janet Yellen’s track record so far has been a sparkling success. On the other, there’s a problem with a stubborn, uncooperative indicator: inflation.
The Fed’s preferred price measure has averaged 1.1 percent since Yellen took the U.S. central bank’s helm in February 2014 -- a significant miss of the Fed’s 2 percent inflation target. It averaged 2.5 percent during Alan Greenspan’s chairmanship between 1987 and 2006, and 1.9 percent during eight years under Ben Bernanke.
If that trend continues, and with seven months left in Yellen’s four-year term unless she’s reappointed by President Donald Trump, the performance would make her the only chair in 30 years not to achieve sustained inflation close to the Fed’s declared goal. That’s a stunning irony for Yellen, who was characterized as a monetary “dove” when she took office because of the view that she’d tolerate higher inflation in exchange for labor market gains.
“It is eye-opening,” said Torsten Slok, chief international economist at Deutsche Bank AG in New York. For all the policy expansiveness of central banks, “we still have not been able to generate inflation. All of us in the PhD economics community have to be humbled by this.”
U.S. central bankers are monitoring inflation performance with caution, even as they seem prepared to raise interest rates at their policy meeting June 13-14. Governors Lael Brainard and Jerome Powell said in speeches last week that they’re watching inflation carefully while favoring a continued gradual pace of rate increases.
“If the soft inflation data persist, that would be concerning and, ultimately, could lead me to reassess the appropriate path of policy,” Brainard told the New York Association for Business Economics on May 30.
So far, low rates of inflation haven’t hurt the U.S. economy, and prices are rising gradually with wages. The Fed’s preferred gauge of price pressures -- the personal consumption expenditures price index -- averaged 1.9 percent on a year-over-year basis for the first four months of 2017, close enough to the 2 percent target given the imprecision of price measurements. That’s an increase from 1.1 percent the previous year, and 0.3 percent in 2015.
However, prices minus food and energy, a guide to where longer-run inflation is headed, have decelerated on a year-over-year basis every month this year, finishing April at 1.5 percent.
In Yellen’s defense, the Fed only specified their low-inflation goal as 2 percent in 2012, making their target a more explicit performance metric than in the past. She also inherited historically low inflation and growth as the economy healed from a severe recession that ended in 2009.
What’s more, the Fed’s aggressive and early action during the crisis helped the U.S. economy rebound more strongly than those of Europe and Japan. And Yellen, the 15th person and first woman to chair the Fed, has served for a shorter term than many of her predecessors, including the past three. In time, inflation could grind higher on her watch.
But the longer inflation persists below the target, the less confidence consumers, businesses and investors have in the Fed’s ability to hit it. In the longer run, constant misses on an inflation target can erode confidence in the central bank’s ability to achieve it, and drag expectations about future prices lower.
The Atlanta Fed’s Business Expectations Survey in April was revealing on that count. When asked what the Fed’s longer-run inflation target was, 48 percent of businesses answered 2 percent. When asked about the Fed’s tolerance of inflation above or below the target, 38 percent said the Fed was more likely to accept inflation below the target. Only 25 percent viewed the Fed’s approach as equally willing to accept price gains above or below its objective.
A New York Fed survey of consumer expectations of inflation three years ahead stood at 2.9 percent in April, down from 3.2 percent three years earlier.
“A long-term downward trend in inflation expectations is a problem and needs to be addressed,” said Lewis Alexander, chief economist at Nomura Securities International Inc. in New York. Officials need to have a robust debate about the target level, and the way it’s designed and communicated, he said.
Yellen’s legacy so far can’t only be judged on prices, though. The Fed also has a mandate to achieve maximum employment, and on that score, her record shines.
The central bank’s ultra-cautious approach to reeling in emergency stimulus has kept the expansion on track and supported big gains in the labor market.
The unemployment rate fell to 4.3 percent in May, a 16-year low, while a broader measure of labor slack -- one which includes workers stuck in part-time jobs who would prefer full-time work -- has fallen to 8.4 percent from 12.6 percent when Yellen became chair.
Remarkably, the labor force participation rate, a measure of what percentage of the working-age population either has a job or wants a job, has stopped declining, a sign that more people are opting to stay in their jobs or look for a job rather than retire or opt out due to discouragement.
Fed officials are counting on a workhorse economic model that suggests reduced slack in the labor force helps lift wages. Employers eventually pass those higher payroll costs along to consumers, raising inflation, the theory suggests.
Whether that model is functional in an economy where both consumers and businesses bear deep scars from the recession remains to be seen. As wages have risen, some companies so far have opted to internalize that into lower profits rather than pass it along in the form of higher product prices.
“The committee has long thought they would get inflation up a little bit faster,” said Michael Hanson, chief U.S. macro strategist at TD Securities in New York. “We are learning that creating inflation is not so easy.”