Economy Parties a Bit Like 1999 as Yellen Heads to Jackson Hole

  • Forces buffeting U.S. economy reminiscent of the late 1990s
  • Fed chief to discuss financial stability in Aug. 25 speech

Saxo Says Jackson Hole Shaping Up as Hype

Talk about Flashback Friday.

In 1999, then-Federal Reserve Chairman Alan Greenspan kicked off the central bank’s annual Jackson Hole symposium by highlighting the impact of rising stock prices on an economy that was then enjoying low inflation and low unemployment.

Now, Janet Yellen faces a similar confluence of economic forces as she prepares for what might be her last speech at the Wyoming conference as Fed chair on Friday. And, like Greenspan before her, she has to decide how much weight to give to each as she tries to keep the economic expansion on track.

Buoyant asset prices and low unemployment argue for Yellen to press ahead with interest-rate increases -- or even accelerate them. Weak inflation suggests she might even want to consider providing more stimulus, not less.

“Tightening wins by a vote of two to one,” Ethan Harris, head of global economic research at Bank of America Corp. in New York, said. He sees the Fed raising rates again in December and further next year.

That would mimic the tack Greenspan took 18 years ago, when, faced with a frothy stock market, he continued to hike rates until May 2000.

The result was a disaster for the stock market -- the technology-heavy Nasdaq Composite Index plunged by 78 percent over a 2-1/2-year period from its peak as the dot.com bubble deflated -- but not all that bad for the economy. Gross domestic product did contract during 2001, but the fall was so small that former Fed Vice Chairman Alan Blinder has called it a “recessionette.” And inflation remained contained.

“There are a lot of similarities,” between the late 1990’s and today, said Laurence Meyer, who was a Fed governor from 1996 to 2002 and now heads his own Washington-based consulting firm.

At a 16-year low of 4.3 percent, joblessness is at exactly the level it was when Greenspan spoke in 1999, while the underlying inflation rate that excludes energy and food prices is just a smidgen higher, at 1.5 percent. U.S. stock prices, meanwhile, are in the midst of a multi-year bull market, just as they were back then.

Easy Money

Yellen, whose term as Fed chair expires in February 2018, has already mimicked the Greenspan of that era in one important respect. Just as he did, she’s taken advantage of low inflation to keep monetary policy easy, in the process fostering a continued reduction in joblessness.

“Greenspan decided in the late ’90s to take a chance and let the unemployment rate drift down to levels that were considered dangerous in terms of inflation,” said Blinder, now a Princeton University professor. “The Yellen Fed has done more or less the same.”

The rate eventually fell to 3.8 percent in 2000 and that could happen again. Indeed, Goldman Sachs Group Inc. chief economist Jan Hatzius sees it dropping to that level by the end of 2018.

Policy makers back then had a good explanation for why inflation remained quiescent even as the jobs market tightened. A pick-up in worker productivity allowed companies to pay their employees more without reducing profits. So firms didn’t feel compelled to raise prices in response. And economic growth was super-strong as well, averaging an annualized 6.1 percent in the second half of 1999.

No Pay Rise

What’s different this time is that it’s not only inflation that hasn’t risen in response to lower unemployment. Wage growth hasn’t accelerated either, perhaps in part because productivity has been lackluster. And economic growth has been limp.

At their meeting last month, Fed officials discussed a variety of rationales for the subdued inflation, including the possibility that increased competition and innovation were limiting the ability of companies to lift prices. But policy makers reached no consensus on what is going on, according to the minutes of the gathering.

Given all the uncertainty, some central bankers have suggested the Fed hold off from further rate increases until it sees clear evidence that inflation is reversing course and rising toward its 2 percent goal.

“We should be very patient and judicious,” Dallas Fed President Robert Kaplan, a voting member this year of the rate-setting Federal Open Market Committee, told the Lubbock Chamber of Commerce on Aug. 17.

Others though want to press ahead. They point to above-trend growth of both the economy and the jobs market and easy financial conditions as justifying that stance.

Rising stock prices, narrowing credit spreads and a weaker dollar have all combined to make financing easier in spite of repeated rate hikes by the Fed. That’s a major reason why New York Fed President William Dudley has said he’d favor another rate increase this year if the economy evolves as expected.

Yellen, who will deliver a speech Friday on financial stability in Jackson Hole at 8 a.m. local time, or 10 a.m. New York time, called asset prices “somewhat rich” during a June appearance at the British Academy in London. She declined though to say whether those valuations were justified, noting they needed to be measured against long-term interest rates, which are low.

The Fed chief subsequently told lawmakers in July that she judged the overall risks to financial stability as “moderate.” The banking system has been fortified by regulatory-driven increases in capital and liquidity, she said.

What would be worrying would be a build-up in leverage on the back of elevated asset prices, but that isn’t happening, according to Yellen.

“I’m not particularly concerned about where our asset prices are today,” Dudley told the Associated Press on Aug. 14. “I’m hoping that we can just act in a way to sustain this economic expansion so it can benefit a broader set of Americans,” he said.

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