First, see U.S. Inflation Accelerates to Six-Year High, Eroding Wages by Katia Dmitrieva of Bloomberg.
Then see The Fed’s Biggest Dilemma: Is the Booming Job Market a Problem? Jerome Powell, the chairman of the Federal Reserve, has to figure out whether inflation is around the corner. The wrong choice could cripple the economy by Nick Timiraos of The WSJ. Excerpts:
"Only twice in the past half-century has unemployment fallen to its current rate of 3.8%—for a few years in the late 1960s and for one month in 2000.
The ’60s episode spurred years of soaring inflation that would take a decade for policy makers to corral. The latter coincided with a technology bubble that, when it burst, caused the 2001 recession.
The Fed is likely to announce Wednesday it is raising its benchmark short-term interest rate to a range between 1.75% and 2%, the latest in a series of increases aimed at avoiding such outcomes by keeping the economy on an even keel."
"He [Fed chair Powell] and other Fed officials have been studying the low unemployment episode of the 1960s for clues, poring over simulations to understand what might happen if unemployment keeps falling and debating whether traditional models for joblessness and inflation still work. The Fed has long operated under the framework that if joblessness falls too low, rising labor costs dominate and lead to higher inflation."
"Officials seek 2% annual inflation because they view that as consistent with an economy with healthy demand for goods and services.
The employment debate is taking on more urgency because joblessness is expected to keep falling due to a burst of economic stimulus from recent tax cuts and government spending increases.
If hiring and workforce participation trends since January continue, unemployment would reach as low as 3.3% by December, way below Fed officials’ estimates of the level that is sustainable over the long run.
Among the questions preoccupying Mr. Powell: Could a tighter labor market bring in people not already in the job market and raise workforce participation rates? If that happens, the economy will be in a position to draw on those unused resources and keep growing without overheating. That would allow the Fed to raise rates more slowly than it otherwise would.
If there aren’t people outside of the labor market ready to enter, the Fed could raise rates more aggressively. Higher inflation requires tighter credit to keep price pressures in check."
[former chair] "Janet Yellen . . . was convinced that low unemployment rates eventually will lead to higher inflation"
"Key to the Fed’s considerations is an economic concept developed in the late 1960s by Milton Friedman known as the natural rate of unemployment. Some economists believe this level balances the supply and demand for labor, and that below it, inflation accelerates"
"Their estimate tumbled from 5.1% three years ago to 4.7% last year to 4.5% in March."
"Officials now seem less sure that low interest rates will keep boosting workforce participation"
"Mr. Powell has said the natural rate of unemployment could be anywhere from 3.5% to 5%."
"the Phillips curve has been flat for the past 20 years, meaning big swings in unemployment haven’t significantly affected U.S. inflation."
"A few Fed officials have grown skeptical of the central bank’s devotion to the Phillips curve"
"They hesitate to rely on a model that would have called for more aggressive interest-rate rises in 2015 and 2016, because the jobless rate implied inflation would soon heat up. In fact, millions of Americans found jobs and inflation remained low."
"A second group of officials rejects this thinking. They say unemployment is well below a sustainable level. They worry it is just a matter of time before imbalances emerge—either excess inflation or financial bubbles—and if they wait until then, they will have to raise rates aggressively, causing a recession."
"Looking at city-level data, economists found inflation picked up more quickly once the jobless rate fell below 3.75%. One of the researchers, UBS’s Mr. Detmeister, said the paper argues for maintaining the Fed’s current approach of raising interest rates with the goal of anticipating where the economy will be 12-to-24 months ahead."
"Many Fed officials . . . say globalization, technology and demographic changes mean a low-unemployment economy may not face the same price pressures as it did in the 1960s."
"Today’s economy has more college-educated workers than in the past, which depresses the natural rate of unemployment because they have lower unemployment rates than others."
"In the 1960s and 1970s, if inflation went up one year, consumers expected it to rise by at least as much the following year. Officials believe such expectations can be self-fulfilling as workers demand pay increases and businesses raise prices in anticipation.
But in the early 1980s, the Fed ratcheted interest rates up into the double-digits, slowing inflation dramatically by pushing the economy into a severe recession. It demonstrated the central bank’s commitment to keep prices in check, and the approach has held since then.
Fed research published in 2016 used the 1960s experience to measure the point where inflation pressures begin to harm the economy, including by leading expectations of higher prices to become self-reinforcing as they did in the 1970s. The research, which was presented to Mr. Powell, concluded this happens when inflation rises by 3% on a sustained basis, using the Fed’s preferred gauge and excluding volatile food and energy categories. Using this gauge, inflation is currently rising 1.8%.
Given the anchoring of inflation expectations, Mr. Kashkari said it is no surprise that inflation is unresponsive to low unemployment today. “The more credibility we have with the market and with employees and employers, the less responsive they are going to be to minor changes in the economy,” he said."Related posts:
Is There A Neutral Interest Rate? If So, How Much Is it?
Is The Phillips Curve Dead In Japan? Maybe not
Is The Phillips Curve Not Holding Up Well Because The Service And Goods Sectors Are Behaving Differently?
Has the Fed Flattened the Phillips Curve?
Nobody knows what the natural rate of unemployment is today
More on the natural rate of unemployment
How Central Banks Differ In Their Methods Of Calculating Inflation.
Fed Officials Disagree On Threat Of Inflation (from 2009)
Fed Chair Janet Yellen: "there remains considerable slack in the economy" (from 2014)
Professor Mark Thoma of the University of Oregon had a post at his blog on the disagreement over what the optimal inflation rate is called Do We Need to Rethink Macroeconomic Policy? Some economists think maybe 4% would be okay. But this article gives you a good idea of the issues and controversies surrounding the unemployment-inflation tradeoff. Excerpt:
"Just to be clear, the relative price of good A to good B is PA/PB. If there is inflation and one of the two prices is stickier than the other, then the two prices will change at different rates in response to inflation. This pushes relative prices away from their fundamental values, and this in turn distorts resource flows (which leads to losses and unemployment as resources are subsequently reallocated). The higher the inflation rate, the faster these prices become distorted and the higher the subsequent costs. This is not the only cost of inflation, but on this basis alone it's likely that at some point the costs of inflation will exceed the benefits. The hard question is where the breakpoint is (partly because we don't have good estimates of either the costs or the benefits, so it's possible to support most any position by picking and choosing among the empirical studies). I'd be very uncomfortable with a rate over 4%, 4% itself seems a bit high, but 3% isn't so hard to accept."