Low Inflation Is No Puzzle, San Francisco Fed Finds: Eco Pulse

New research shows that acyclical indexes like health are holding back price gains

Inflation has become the great mystery of 2017 for Federal Reserve policy makers, but maybe it isn’t so baffling after all. 

That’s the conclusion reached in new San Francisco Fed research, which takes a look at the components of inflation. The ones that respond to the business cycle appear to have picked up – it’s everything else causing the problem. It’s the first study in this week’s economic wrap, which also looks at the outlook for global food demand, the utility of natural rates, the cyclical nature of student loan defaults and German labor participation among older workers. Check this column each Tuesday for the latest research from around the world. 

Behind the inflation mystery

What's Down With Inflation?
Published November 2017
Available on the San Francisco Fed website

Price gains in the U.S. have been holding stubbornly below the Fed’s 2 percent target, puzzling officials as unemployment falls steadily lower. New San Francisco Fed research shows that when you look at sub-indexes that are pro-cyclical, meaning they respond to slack in the economy, inflation has returned to its pre-recession level. It’s the categories that don’t respond strongly to changes in the business cycle that have been persistently low, “suggesting that idiosyncratic factors have helped hold down PCE inflation.” 

For example, cuts to Medicare payment growth rates have been holding down health-care sector inflation, which will probably continue to drag on overall price gains in the foreseeable future. “While some cuts are expected to dissipate in the coming years, it seems unlikely that Medicare payment growth will return to its pre-recession level under current legislation,” researchers Tim Mahedy and Adam Shapiro write. 

Weekly demo(graphic)

As the global population grows and low-income countries play catchup, food demand could more than double by 2050, new World Bank research shows

Natural rates: no longer useful?

Should We Get Rid of the Natural Rate Hypothesis?
Published November 2017
Available on the NBER website

Former International Monetary Fund research director Olivier Blanchard casts a skeptical eye on the natural rate of unemployment in a new paper, concluding that monetary policy makers should still use the concept – but very cautiously. Quick review: Milton Friedman laid out a hypothesis 50 years ago that there’s a level of unemployment that arises from structural quirks in the economy, and which is independent of monetary policy. If the central bank allows joblessness to stay below that level for an extended period of time, it will push inflation higher. The problem with this theory, a backbone of modern monetary policy, is that the relationship between unemployment and price gains hasn’t really held up for the past 20 years. 

Still, there isn’t enough evidence to disprove it, so officials should keep the natural rate hypothesis as their base case, Blanchard concludes. That said, in a world where evidence against the theory is slowly piling up, they should also “keep an open mind and put some weight on the alternatives.” For example, it might be worth letting the job market overshoot in order to pull workers back from the sidelines. 

Recession and loan default 

Are Student Loan Defaults Cyclical? It Depends
Available on the New York Fed website
Published November 2017

Students who left college at the height of the recession were the most likely to default on their student loans, New York Fed research shows. The group of students entering repayment in 2010 and 2011 (the ones who graduated in 2009 and 2010) posted higher default rates than subsequent groups, who graduated into a healing labor market. That probably owed to the students’ trouble finding work as unemployment spiked. High default rates during and after the crisis may also owe in part to the fact that people poured into for-profit colleges to weather the downturn, graduating with comparatively poor job prospects. Associate degree students, dropouts, arts and humanities students, and students who attended what the researchers term “nonselective” colleges experienced higher increases in default rates than their peers.

The German gender divide

Old-Age Labor Force Participation in Germany: What Explains the Trend Reversal Among
Older Men? And What the Steady Increase Among Women?
Published November 2017
Available on the NBER website 

German men have been staying in the labor market longer, and researchers from the Max Planck Institute think you can probably chalk that up to changes in pension regulations – in particular the phasing in of actuarial adjustments for early retirement. Education, health and spousal employment don’t seem to explain the U-shaped trend, based on the authors’ analysis. While older women have also been posting higher labor-force participation figures in Germany, that probably reflects a secular trend: Rising participation is true across the age distribution for women and has proceeded steadily, which is not the case for men. 

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