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The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.


March 01, 2013


What the Dual Mandate Looks Like

Sometimes simple, direct points are the most powerful. For me, the simplest and most direct points in Chairman Bernanke’s Senate testimony this week were contained in the following one minute and 49 seconds of video (courtesy of Bloomberg):

At about the 1:26 mark, the Chairman says:

So, our accommodative monetary policy has not really traded off one of [the FOMC’s mandated goals] against the other, and it has supported both real growth and employment and kept inflation close to our target.

To that point, here is a straightforward picture:

Inflation and Unemployment

I concede that past results are no guarantee of future performance. And in his testimony, the Chairman was very clear that prudence dictates vigilance with respect to potential unintended consequences:

Highly accommodative monetary policy also has several potential costs and risks, which the committee is monitoring closely. For example, if further expansion of the Federal Reserve's balance sheet were to undermine public confidence in our ability to exit smoothly from our accommodative policies at the appropriate time, inflation expectations could rise, putting the FOMC's price stability objective at risk...

Another potential cost that the committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may reach for yield by taking on more credit risk, duration risk, or leverage.

Concerns about such developments are fair and, as Mr. Bernanke makes clear, shared by the FOMC. Furthermore, the language around the Fed’s ultimate decision to end or alter the pace of its current open-ended asset-purchase program is explicitly cast in terms of an ongoing cost-benefit analysis. But anyone who wants to convince me that monetary policy actions have been contrary to our dual mandate is going to have to explain to me why that conclusion isn’t contradicted by the chart above.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

March 1, 2013 in Employment, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

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November 20, 2012


Rose-Colored Glasses Make the Future Look Blurry: Sales Uncertainty as Seen by the November BIE

Uncertainty is widely cited as being a significant contributor to the economy's subpar growth. Reddy and Thurm report in yesterday's Wall Street Journal that "half of the nation's 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next," in large measure because of rising economic uncertainty. But how uncertain is the current economic outlook? A few economists have attempted to measure business uncertainty, often by using the degree of disagreement between various forecasts, the volatility of certain economic indicators, or some combination of the two. (Two such approaches can be found here and here.)

We thought we'd use our Business Inflation Expectations (BIE) survey to see if we could gauge the degree of business uncertainty directly. Last week, we asked our panel to assign probabilities to various sales outcomes for their businesses for the coming year. (This methodology is the same one we have been using to measure inflation uncertainty, except in this case our business panel was asked to reveal their expectations for unit sales growth over the year ahead.)

Specifically, we put to our panel the following statement:

Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to unit sales over the next 12 months.

Panelists were given the following five unit sales outcomes:

  1. down (less than –1 percent)
  2. about unchanged (–1 percent to 1 percent)
  3. up somewhat (1.1 percent to 3 percent)
  4. up significantly (3.1 percent to 5 percent)
  5. up very significantly (greater than 5 percent)

One hundred and ninety-four businesses responded, and here's what they told us: On average, firms expect unit sales growth of about 1.2 percent in the coming year. That's more pessimistic than the real gross domestic product (GDP) forecast of the consensus of economists for the year (about 2 percent). But the range of possible outcomes seemed, to our eyes a least, to be large and unbalanced.

Consider the chart below, which shows the probabilities the panel, on average, assigned to the various sales outcomes. They assigned a 48 percent chance that their unit sales will grow 1 percent or less in the coming year, balanced against only 23 percent likelihood that unit sales will grow more than 3 percent over the next 12 months. In other words, in the minds of our BIE panel, the range of likely sales outcomes over the year ahead is pretty wide, with a fairly weighty chance that unit sales growth may not move in a positive range at all.

121120b

Perhaps we are making a bit too much of the size of the uncertainty businesses are attaching to the outlook. After all, we don't know what uncertainties firms face even in the best of times (since this is the first time we've asked this question). But when we dug into the data a little deeper, we found something else of interest. The degree of economic uncertainty varies widely by firm. Moreover, the greatest uncertainty about the future was held by the panelists who have the most optimistic sales outlook.

Check out the table below. It shows the degree of sales forecast uncertainty on the basis of whether a firm's sales projection is high or low.

121120_tbl

Panelists with the most optimistic sales expectations (the 39 firms with the highest sales forecasts) predicted unit sales growth of a little more than 3.5 percent this year, compared with about a 0.5 percent decline in unit sales for the 39 most pessimistic panelists. But also note that those who are relatively optimistic about the coming year have much greater uncertainty about their future than those who are relatively pessimistic—in fact, they're almost twice as uncertain.

What the November BIE survey seems to be saying is that it isn't just that an uncertain business outlook is reining in our growth prospects, but that the outlook is especially uncertain for the firms that think they have the best opportunity for expansion. Apparently, those wearing rose-colored glasses are having trouble seeing through them.

Note: The regular November Business Inflation Expectations report will be released Wednesday morning.

Mike BryanBy Mike Bryan, vice president and senior economist,

Laurel GraefeLaurel Graefe, economic policy analysis specialist, and

Nicholas ParkerNicholas Parker, economic research analyst, all with the Atlanta Fed

 


November 20, 2012 in Business Inflation Expectations, Inflation, Inflation Expectations | Permalink

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But the coefficient of variation is far higher in the bottom quintile, right?

Posted by: Sebastien Turban (@PtitSeb) | November 21, 2012 at 02:21 PM

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November 09, 2012


Getting the Questions Right

Among the plethora of post-election exit-poll results, the CNBC website highlights a particularly interesting response, linked from the mega-blog Instapundit with the title "Voters Worry More About Inflation Than You Think." The CNBC article itself, written by Allison Linn, describes the poll results in more detail:

It's no surprise that voters in Tuesday's presidential election identified the economy as the No. 1 issue in the campaign, far ahead of health care and the federal budget deficit.
But it was a surprise that so many voters identified rising prices as the biggest economic problem they face.

Linn notes something of a disconnect between this view and the facts on the ground:

...inflation has generally been running well under 2 percent, and Federal Reserve bankers repeatedly have said they feel comfortable that low inflation allows them to keep interest rates at rock-bottom levels.

Yet in an exit poll of more than 25,000 voters conducted by NBC News, 37 percent identified rising prices as the biggest problem facing people like them.

Unemployment was cited by 38 percent, only slightly more than the number who said inflation was their top economic concern. Taxes were named by 14 percent and the housing market was the top concern of 8 percent.

The policy stakes on understanding these responses are pretty high. In the end, the cost of inflation comes in the form of how it may distort behavior and the allocation of resources. So the expectation or perception of significant inflation is at least as pernicious as the measurement itself.

But what, exactly, does this concern about "inflation" actually reflect? Probably not what we think. Some time ago, my colleagues Mike Bryan and Guhan Venkatu (from the Cleveland Fed) made note of "The Curiously Different Inflation Perspectives of Men and Women." Their findings are pretty informative:

Over the past few years, the Federal Reserve Bank of Cleveland, with assistance from the Ohio State University, has studied household inflation perceptions and expectations using a monthly survey of approximately 500 Ohioans (the FRBC/OSU Inflation Psychology Survey). This survey, which records respondents' perceptions of price changes over the past 12 months as well as their expectations for price changes over the next 12 months, has uncovered a surprising result. The data indicate that the public's estimates and predictions of inflation are significantly and systematically related to the demographic characteristics of the respondents. People with high incomes perceive and anticipate much less inflation than people with low incomes, married people less than singles, whites less than nonwhites, and middle-aged people less than young people. This Commentary describes what is perhaps the most curious observation of all: Even after we hold constant income, age, education, race, and marital status, men and women hold very different views on the rate at which prices are changing.

...[S]tatistical tests reveal that even after we adjust for the respondents' age, race, education, and income, women in our survey tended to think inflation was 1.9 percentage points higher than men. A similar examination of respondents' predictions of future inflation yields the same basic result: After we account for other major demographic factors, on average, women expected prices to rise 2.1 percentage points more than men.

It is important to note that this result was not unique to the Cleveland Fed study:

An examination of survey data collected by the University of Michigan (which has recorded the inflation forecasts of U.S. households on a monthly basis since 1978) reveals that women consistently hold higher inflation expectations than men, even after we hold constant other important demographic characteristics of the respondent.

Most intriguing of all, the systematic overstatement of inflation by all consumers, relative to official statistics, and the difference in responses between men and women are not a result of ignorance about the facts, according to those official statistics:

In the August 2001 FRBC/OSU survey, we sought an answer to this question by asking, "Have you heard of the Consumer Price Index (CPI) before?" and "By about what percentage do you think the CPI went up (or down), on average, over the last 12 months?"

A significantly higher proportion of men had heard of the CPI compared to women (75 percent versus 61 percent, respectively). For those who had heard of the CPI, the average perception about how much it had risen over the past 12 months was surprisingly accurate—a perceived increase of 2.9 percent compared to an actual increase of 2.7 percent. It is also very interesting that men and women perceived the CPI's growth rate nearly identically (2.8 percent versus 3.1 percent, respectively.) However, of those who knew of the CPI, the average perception of price increases was 6.7 percent. And even within the subgroup of respondents who knew of the CPI, men had a significantly lower perception of price increases than did women (6.0 percent vs. 7.4 percent). In other words, the public believes that prices are rising more than the CPI reports, and women more so than men.

There are a couple of hypotheses that could be advanced to explain results like this. One is that the conspiracy crowd is correct and the official statistics are rigged and vastly understate true inflation. But that wouldn't get us anywhere near an understanding of why survey responses about inflation would be systematically different across men and women, higher- and low- income individuals, and just about any other demographic cuts we might make.

A second possibility it is that individuals' responses reflect price changes in their own personal market basket, which may differ from that of the average urban wage earner whose habits are reflected in the Consumer Price Index (CPI).That might explain why any demographic sub group could arrive at different inflation perceptions, but it doesn't explain why respondents as a whole systematically overstate inflation relative to the CPI.

I think the most likely explanation is that the survey respondents are expressing a much different concern than whether they believe food, gas, autos, banking services, or whatever are increasing or are likely to increase faster than the official statistics indicate. My guess is that they are telling us that they are concerned that their real—or inflation-adjusted—incomes are not rising fast enough to comfortably sustain their desired spending:


As I noted, the policy stakes are high. In the current environment, the policy prescription for fighting an incipient rise in inflation expectations would be much different than one deployed to address the reality of the chart above. All the more reason to make sure we understand the questions we are asking and the responses we get back.

Just to be sure, we monitor inflation trends and inflation expectations from a number of perspectives: Treasury Inflation Protected Securities (TIPS), forecasts, and the Business Inflation Expectations (BIE) survey, to name just three. And all are available on the Atlanta Fed's Inflation Project for the terminally curious to monitor with us.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


November 9, 2012 in Inflation | Permalink

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The question of inflation perceptions is indeed the right question, and some recent work has been done on this. See "'Real-Feel' Inflation: Quantitative Estimation of Inflation Perceptions," Business Economics, Vol. 47, No. 1, National Association for Business Economics, pp. 14-26, which tries to quantify some of the known cognitive biases that operate on inflation perceptions (or at least, to provide the first pieces of a model to do so, were it calibrated properly).

You can find a copy of the paper, although not the BE version, here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1661941

Posted by: Michael Ashton | November 09, 2012 at 11:42 AM

You are looking at the personal income data that because of the massive inequality in the US significantly overstates the income of the bulk of the population.

If you look at the average hourly and weekly earnings published by the BLS you get a very different picture of real income growth.

Average hourly earnings growth is at the record low of 0.8% and with 2% that leaves real income growth much, much weaker than your chart implies. Moreover, the higher inflation stems from food and oil that is a necessity for
the 80% of the population this measure covers.

Posted by: Spencer | November 09, 2012 at 12:24 PM

I would think an analysis of gender perception differences should take into account the % of purchasing decisions by gender.

Women make (according to studies) 70% of the purchasing decisions and by that metric, it shouldn't be a surprise that women are more tuned into household budget.

Good points by Spencer - the 80% (and all, except the disposable income for the top 20% obviously doesn't receivce the same incemental impact as the bottom 80%)... face inflationary costs 3X the rate of headline CPI when faced with health care, higher ed and energy costs.

Posted by: Barclay | November 10, 2012 at 09:53 AM

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November 02, 2012


Has Fed Behavior Changed?

To the titular question, Steve Williamson thinks the answer is "yes":

… the behavior of the FOMC has changed. Either it cares about some things it did not care about before (and in a particular way), or it cares about the same things in different ways—in particular it is less concerned about its price stability mandate.

Part of the Williamson case relies on an earlier post, where Williamson illustrates deviations of the actual path of the federal funds rate paths from his own estimated version of the Taylor rule:

New Keynesians like to think about monetary policy in terms of a Taylor rule, which specifies a target for the federal funds rate as a function of the "output gap" and the deviation of the actual inflation rate from its target value. According to standard Taylor rules, the fed funds target should go down when the output gap rises and up when the inflation rate rises. You can even fit Taylor rules to the data. I fit one to quarterly data for 1987-2007, and obtained the following:

R = 2.02 - 1.48(U-U*) + 1.17P,

where R is the fed funds rate, U is the unemployment rate, U* is the CBO natural rate of unemployment (so U-U* is my measure of the output gap) and P is the year-over-year percentage increase in the PCE deflator. You can see how it fits the historical data in the next chart.

So that's how the Fed behaved in the past. If it were behaving in the same way today, what would it be doing? Given that U = 7.8, U* = 6.0, and P = 1.5, my Taylor rule predicts R = 1.1%....

So, the Fed's behavior seems to have changed.

An obvious point: It is clear from Williamson's chart above that the predictive power of his version of the Taylor rule is far from perfect. In fact, through 2007 the standard deviation of the estimated rule's prediction error is 1.3 percentage points. From that perspective, the difference between a Williamson-Taylor rule funds-rate prediction of 1.1 percent and the actual current value of 0.14 percent doesn't seem so dramatic. I don't really see an obvious deviation from previous behavior.

More to the point, unless the metric is an absolutely slavish devotion to a particular form of the Taylor rule, I'm not exactly sure what evidence supports a conclusion that the Federal Open Market Committee (FOMC) is now "less concerned about its price stability mandate." As I argued a few weeks back, I think it is not too much of a stretch to construct a justification of post-crisis Fed actions up to the September decision entirely in terms of support for the FOMC's price stability mandate.

I don't take any great exception to Williamson's claim that, with respect to the FOMC's stated inflation objective, things look pretty much on target:

If we look at a longer horizon, as I did here, from the beginning of 2007 or the beginning of 2009, you'll get something a little higher than 2.0% (I didn't have the most recent observation in the chart in the previous post). Too low? I don't think so.

Furthermore, in my previous post I noted that while there is a plausible case that previous asset purchase programs were required to maintain this salutary record on the inflation front, the case is arguably less plausible for "QE3." But, to my mind, that just isn't enough evidence to conclude that the FOMC has downgraded its price stability goals.

Consider a homeowner with the dual mandate of keeping both the roof of the house and the driveway in good repair. If the roof isn't leaking but there are cracks in the driveway, I think you would expect to see the owner out on the weekend patching the concrete. I don't think you would conclude as a result that he or she had ceased caring as much about the condition of the roof. I do think you would conclude that attention is being focused where the problem exists.

I suppose the argument is that the Fed is raining so much liquidity down on the world that the roof is, sooner or later, bound to leak. The FOMC has expressed confidence that, if this happens, it has the tools to patch things up and will deploy those tools as aggressively as required to meet its mandate. I guess Steve Williamson feels differently. But that, then, is a difference of opinion about things to come, not about the facts on the ground.

Update: Here's Steve Williamson's response.

David Altig By Dave Altig, executive vice president and research director at the Atlanta Fed

November 2, 2012 in Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

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I think Williamson's problem is that his U*=6 is wrong. There's been plenty of discussion in the econosphere about how the CBO's estimates of output and employment potential have been downwardly biased in recent years. Part of this reflects uncertainty about the extent to which the downturn was structural, but a lot of it is also just a matter of the data being truncated--as more data comes in, the trend estimates will be revised back up due to smoothing processes.

The results on Williamson's Taylor rule are dramatic. First, update the current unemployment to 7.9 instead of the previous 7.9 and it drops from R=1.1% to just 0.98%. Then lower the natural rate of unemployment down to a more realistic long run rate of 5.5% and the predicted interest rate drops to 0.22%, which is within the window prescribed by the fed.

Now, 5.5% is much closer to the natural rate normally used in Taylor rule calculations. Williamson did not find evidence that the Fed was behaving differently, but rather advocating that it should behave differently by being more pessimistic than normal about the economy's potential.

Posted by: Matthew | November 04, 2012 at 07:32 AM

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September 27, 2012


How Big Is the Output Gap? More Perspectives from Our Business Inflation Expectations Survey

Opinions vary widely about how much slack there is in the economy these days. Some say a lot—some say not so much.

Last month, we reached out to members of our Business Inflation Expectations (BIE) panel for their take on the issue. The panel indicated they had more pricing power in August than they did last October. OK, that doesn't exactly gauge the amount of slack businesses think they have, but it does suggest that, however much slack there is, it's been shrinking.

Another detail revealed by our August inquiry was that retailers think they have more pricing power compared with manufacturers—a pretty good sign the latter is experiencing more slack than the former.

In this month's BIE survey we went fishing in the same murky waters, but this time we took a more direct approach. We asked our panel to provide a percentage estimate of how far their sales levels are above/below "normal." Here's what we found: On a gross domestic product (GDP)–weighted basis, the panel estimates that current sales are about 7.5 percent below normal. That's more slack than the conventional estimates, like the Congressional Budget Office's (CBO) measure of the GDP gap, which puts the economy about 6 percent under its potential.

120927_tbl

But perhaps a more interesting observation from our September survey is how widely current performance varies by sector and size within our panel. Retailers, for example, say their current sales are a little less than 2 percent below normal. And firms in the leisure/hospitality and the transportation/warehousing sectors—sectors where growth has been particularly robust in recent years—say they are operating at, or just a shade above, normal levels.

Compare these estimates with those from durable goods manufacturers, which report that their current sales levels are nearly 12 percent below normal, and finance and insurance companies, which say they are almost 17 percent below normal. And construction firms? Well, best not even ask them.

And the amount of slack firms are reporting isn't just a reflection of their sector of the economy—size also matters. Firms with more than 500 employees say their current sales levels are a little less than 5 percent below normal—half as much as the amount of slack being reported by small firms.

So we're led back to the question that kicked this blog post off. How big is the output gap? Some say a lot—some say not so much. And this difference in perspective is not just among policymakers. Within the economy, experience varies at least as widely; some firms' sales are still well below normal, while others are telling us that they are very nearly back to normal, and some are already there.

But here's the rub. If the economy represents a constellation of firms operating at widely varying levels of capacity, from what viewpoint should we consider the economy relative to its potential? Are aggregate measures, like the one provided by the CBO or by our "GDP-weighted" approach, appropriate perspectives? Indeed, given widely varying measures of economic performance across firms and industries, how meaningful is an aggregate assessment of economic slack?

Ah, we'll leave these questions for the November survey.

Mike BryanBy Mike Bryan, vice president and senior economist,

Laurel GraefeLaurel Graefe, economic policy analysis specialist, and

Nicholas ParkerNicholas Parker, economic research analyst, all with the Atlanta Fed

 


September 27, 2012 in Business Inflation Expectations, Inflation, Inflation Expectations | Permalink

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Normal relative to what? To levels at the height of the bubble? Is that really a measurement of the output gap?

Posted by: Dave Schuler | September 28, 2012 at 10:04 AM

"If the economy represents a constellation of firms operating at widely varying levels of capacity, from what viewpoint should we consider the economy relative to its potential?"

maybe a fair question, but one unlikely to be addressed by a survey. One can make the same point about inflation: At any one time, some prices are rising and some are falling, so how meaningful is an aggregate measure of the overall price level? That's the macro question for the ages. Also, you ignore the fact that the rate of growth (or rebound) and ability to add capacity is different for each industry. It could be, for example, that some industries will rebound faster or slower than the overall economy and have the ability to add capacity faster (so the measured degree of slack is essentially a function of the degree of fixed or sticky cost structure).

Overall it sounds to me that while the estimate is different than the CBO, the results are still broadly consistent subject to small sample error.


Posted by: dwb | October 01, 2012 at 08:35 PM

difference in perspective is not just among policymakers. Within the economy, experience varies at least as widely; some firms' sales are still well below normal, while others are telling us that they are very nearly back to normal, and some are already there.

Posted by: escort pigerne | October 22, 2012 at 03:26 AM

And the amount of slack firms are reporting isn't just a reflection of their sector of the economy—size also matters. Firms with more than 500 employees say their current sales levels are a little less than 5 percent below normal—half as much as the amount of slack being reported by small firms.

Posted by: sexpiger | February 16, 2014 at 04:27 PM

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August 23, 2012


Do Firms Have Pricing Power?

Here's a question every policymaker would like to know the answer to: How much slack is there in the economy? You know the drill: If there's lots of slack, firms have little power to pass cost increases on to customers. But as the economy approaches full employment, the pricing power of firms strengthens, and cost pressures get more readily passed along. The problem is, there doesn't seem to be any practical consensus about the amount of slack in our economy. To paraphrase a well-known adage widely attributed to Nobel Laureate Ronald Coase, we've been torturing the Phillips Curve, but it isn't talking.

We wondered if businesses might be in a better position to say what kind of pricing power they have. So this month we asked our Business Inflation Panel to weigh in on how they might adjust their prices in the face of a hypothetical, unanticipated increase in costs. Not knowing what kind of cost pressure a firm might respond to, we randomly sorted our panel into two groups—one given a 2 percent cost-increase scenario, and one given a 6 percent cost-increase scenario. Here's what we learned:

On average, firms faced with the 2 percent cost increase were likely to pass about 1.3 percentage points (or 66 percent) to their customers. In the portion of our panel considering the 6 percent cost increase, the average impact on customer prices was 3.8 percentage points (or about 63 percent of the cost increase). So in the aggregate, firms think they can pass about two-thirds of any cost increase through to prices, and that belief holds roughly true whether the cost increase is relatively modest or somewhat large.

We asked a similar question of our panel last October, but the responses we got then indicated that firms held a more conservative view of their pricing power.

What effect would an unticipated, 2 percent rise in unit costs have on your prices

Of the firms facing the 2 percent cost-hike scenario last October, only 31 percent said they would pass along most of the cost on to their customers, compared with the 53 percent that said they would do so today (see the chart above).

What effect would an unticipated, 6 percent rise in unit costs have on your prices

Likewise, of the panelists asked to consider a 6 percent cost increase, only 37 percent said they would pass most of the increase on to customers last October, compared with 60 percent who said they would do so today (see chart above).

What's behind the reported increase in firms' pricing power since October? Well, we'd be speculating on that point, but one thing that's changed since October is that a smaller proportion of firms are reporting sales levels “less than normal” (54 percent compared with 64 percent in October). Said another way, firms, in the aggregate are reporting less slack today than they were ten months ago—a finding that aligns with recent results from the NFIB small business survey showing a decrease in the percentage of firms that consider poor sales to be the primary issue they face.

Percentage of firms reporting sales less than normal

Comparisons across industry groups also suggest that slack may be influencing firms' reported pricing power. Retailers, for example, say they would pass through about 75 percent of a cost increase to their customers, compared with only 64 percent for manufacturers and 60 percent for other firms. At the same time, retailers are reporting that sales and price margins are closer to normal—a sign that their perception of “slack” is not as great as other firms.

Industry breakdown of the pass-through from the hypothetical...

    

Does the analysis above indicate that firms are running out of slack? Sorry, but we can't quite go that far on the basis of these two surveys. But one thing seems clear—while our panel of businesses says sales levels are still below normal, sales and pricing power are better today than they were last October.

Mike BryanBy Mike Bryan, vice president and senior economist;

Laurel GraefeLaurel Graefe, economic policy analysis specialist;

Nicholas ParkerNicholas Parker, economic research analyst; and

Kate ReesKate Rees, economic research analyst, all with the Atlanta Fed

August 23, 2012 in Business Inflation Expectations, Inflation | Permalink

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August 17, 2012


The (Unfortunately?) Consistent Record of the Recovery

In his last two posts (here and here), economist Tim Duy has done some yeoman work displaying and discussing the economic context of monetary policy decisions past and prospective. Though Wednesday's self-titled post "Data Dump" focuses on the incoming data as a set-up to the next meeting of the Federal Open Market Committee (FOMC), what strikes me is the consistency of the broad macroeconomic outcomes over the course of the recovery. Gross domestic product (GDP) growth has pretty clearly clocked in at about 2 percent...


...and, looking through the quarterly ups and downs, payroll employment growth has clearly trended near 150,000 jobs per month after a slower start in 2010:


The inflation picture shows more variation...


...but in my view, that sort of variation is why it makes sense to think in terms of medium-term performance. "Medium-term" is more a measure of art than science, and I would concede the point that the recovery as a whole would be on the shorter end of that time frame. Suffice it to say that the pace of price-level growth over the past two and a half years wouldn't contradict the presumption that inflation is pretty close to the FOMC's stated longer-run objective.

Duy looks at this performance and sees pretty clear evidence of failure:

The economy continues to settle into a path that is not consistent with either part of the Fed's dual mandate. Moreover, there are very real downside risks to even a tepid outlook...

This is frustrating. What in the world is the point of making a big claim to affirm the nature of the dual mandate and then subsequently ignore any forecasts that indicate you have no faith the elements of the dual mandate will be met anytime soon?

That complaint is not really about the inflation part of the mandate, but the employment/growth part of it. But if you are willing to accept that employment growth remains on a pace of 150,000 jobs per month—and I see no clear evidence to the contrary—it is not at all obvious that the pace of the recovery is inconsistent with the FOMC's view of achieving its dual mandate. Here, for example, are the central tendency ranges of the unemployment rate projections from the FOMC's June Summary of Economic Projections (SEP) and the employment growth that would be required to meet those objectives (with some important assumptions, such as the labor force participation rate remaining at the current level).


Here is the important statement of conditionality, as described in the SEP document:

The charts show actual values and projections for three economic variables [GDP growth, the unemployment rate, and PCE inflation] based on FOMC participants' individual assessments of appropriate monetary policy.

Under appropriate policy—which pretty clearly means mandate-consistent outcomes—the majority of FOMC participants don't seem to think that the unemployment rate will improve that quickly. And, to my point, it is not clear that the trend in payroll employment is inconsistent with that pace of improvement.

Of course, individual contributors to the SEP may have different assumptions about things like the labor force participation rate. More importantly, the SEP is silent on what, in each contributor's view, constitutes "appropriate policy."

And I am certainly begging the important issues. Would the economy have achieved even the somewhat unspectacular pace of 2 percent GDP growth, 150,000 jobs per month, and average inflation near the long-run objective absent large-scale asset purchases ("QE2"), forward guidance (statements indicating that policy rates are expected to be exceptionally low through at least late 2014), and maturity extension programs ("Operation Twist")? Does "appropriate policy" imply that more must be done to achieve even the modest progress in the unemployment rate implied in my calculations above? And could we have (looking backward) or can we (looking forward) do even better with an even more aggressive approach, as many Fed critics argue?

Good questions, those.

David AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


August 17, 2012 in Employment, GDP, Inflation | Permalink

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August 10, 2012


Deflation Probabilities on Our Radar Screen

In the latest Wall Street Journal Economic Forecasting Survey, conducted August 3–6, economists were asked whether they "expect[ed] the Fed to start another round of large-scale bond buying in 2012?" Sixty-three percent answered yes, and 49 percent expected a program would be announced in September, presumably at the end of the next meeting of the Federal Open Market Committee (FOMC) on September 12–13. Obviously this question is of interest to more than just business economists. For example, at his July 17 testimony before the Senate Committee on Banking, Housing, and Urban Affairs, Sen. Mike Crapo asked Fed Chairman Ben Bernanke whether the FOMC should seriously consider more quantitative easing going forward. As part of his response, the Chairman said that "we would certainly want to react against any increase in deflation risk." The entire video exchange can be viewed at the 52–55 minute mark here.

As part of the Atlanta Fed's Inflation Project, we regularly update probabilities of deflation in the Consumer Price Index (CPI) estimated from Treasury Inflation-Protected Securities (TIPS) prices, described here and here. The basic idea is that a recently issued 5-year TIPS has less "deflation protection" than a 10-year TIPS maturing about the same date as the 5-year TIPS. The yield spread between the 5-year TIPS and 10-year TIPS can be used to help estimate the probability of deflation.

The most recent (August 8) estimate puts the 5-year probability of deflation from early 2012 to early 2017 at around 15 percent. As seen in the figure below this probability is up slightly from May, but only about half the readings of the 5-year (2010–15) deflation probability seen in the late summer and early fall of 2010 and considerably below readings seen during the height of the financial crisis in late 2008 and early 2009.


It is important to note that these deflation probabilities are estimates based on a relatively simple model that uses a number of assumptions that not everyone may agree on. Jens Christensen, Jose Lopez, and Glenn Rudebusch at the Federal Reserve Bank of San Francisco have built an alternative model for estimating deflation probabilities that also uses TIPS yields. At the time of the publication of their paper in 2011, their model's probabilities were somewhat lower than—but highly correlated with—ours.

The TIPS market has a number of features that make inferring both inflation expectations and deflation probabilities from them tricky. Most notably, there are unknown liquidity differences between TIPS and nominal Treasury securities. A more direct way of estimating deflation probabilities—or in fact the entire probability distribution of future CPI inflation—using so-called inflation caps and floors has recently been explored by economists Yuriy Kitsul and Jonathan Wright. Inflation caps and floors are essentially options on the Consumer Price Index. We used the Kitsul and Wright method for constructing the implied probabilities of (annualized) CPI inflation over the next five years. As seen in the figure below, this method implies a 13 percent probability that inflation will be 0 percent or negative on average over the next five years. This probability is about at the midpoint of the range that prevailed between October 2009 and March 2012. (See figure 3, on page 29 of Kitsul and Wright's working paper.)


As Kitsul and Wright explain, the market for inflation caps and floors is still quite small relative to the TIPS market. So the deflation probabilities from their model should be considered suggestive, as should our own.

What's the takeaway from all this? Well, readings from the financial market indicate the likelihood of a sustained deflation is currently about 15 percent, or a bit less. That's up from earlier in the year, but not nearly as high as in 2010.

Should we be concerned about the prospect for deflation in the years ahead? This is obviously an important policy question. But I'm not a policymaker; I merely put up the numbers for you to consider. And, of course, we will continue to follow these indicators closely—as can you. Our deflation probability estimates are updated every Thursday and posted on our Inflation Project.

Partick Higgins By Patrick Higgins, an economist in the Atlanta Fed's research department


August 10, 2012 in Deflation, Inflation | Permalink

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Sir,

What relevance would you give to market demand for government securities? I have generally equated high demand with hedging against perceived deflation risk, even though the data suggest the two are actually diverging. Can bond market signalling be used reliably to determine probability of phase change from inflationary to deflationary environment or vice versa?

Posted by: Ben Johannson | August 11, 2012 at 01:59 AM

Sustained deflation seems unlikely. A far more likely explanation/interpretation (that btw agrees with 1 and 2-yr breakeven-implied TIPS inflation over the June/July time period) is that there is a significant chance that one year of the next five will see deflation. In other words: be very afraid.

Posted by: dwb | August 11, 2012 at 01:32 PM

How could one go about assessing the same calculation using PPI vs. CPI? I am curious if there are any notable differences between the underlying index for inflation as it could potentially have implications for profit margins.

Thanks for your time and efforts.

Posted by: Danny | August 15, 2012 at 10:43 AM

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June 25, 2012


Do falling commodity prices imply disinflation ahead?

Cost pressures at the manufacturing level appear to be easing—at least, so say the manufacturers in our Business Inflation Expectations survey. In June, manufacturers reported that unit costs were up only 1.3 percent over the last 12 months, a full percentage point below their assessment at the end of last year. Retailers, on the other hand, report unit cost increases of 2.1 percent, down a bit from May, but 0.3 percentage points higher than in December.

We put a special question to our panel in June that may shed a little light on these patterns. When we asked firms to tell us what has been driving their unit costs over the past 12 months, manufacturers saw considerably less pressure coming from their cost of materials compared with other firms. Perhaps this discovery isn't very surprising. After all, commodity prices have been falling pretty sharply of late, and these costs are especially influential to manufacturers' assessment of the cost environment. (Indeed, in response to a special question we asked our panel in March, manufacturers ranked materials costs as the number-one influence on their pricing decisions.)

Does the fall in commodity prices mean we can expect a pass-through of these lower costs to consumers?

Perhaps. There's certainly a strong intuitive appeal to the "pipeline" theory of inflation. Here's the idea as described by the Bank of England (BOE):

"Consumer prices…can be thought of as the end of a 'pipeline' of costs and prices. The final price will be made up of many different components of cost as well as the retailer's profit or margin… Prices at one stage of the pipeline become costs for the next stage…"

But economists who have looked down the inflation pipeline haven't found flows, but rather trickles. Years ago, Todd Clark of the Cleveland Fed put it this way while he was at the Kansas City Fed: "the empirical evidence… shows the production chain only weakly links consumer prices to producer prices."

So the "inflation pipeline" theory isn't that simple, as the BOE goes on to explain:

"The [pipeline] idea is a simplification… Prices are determined by the interaction of supply and demand. If the cost of raw materials rises, for example, producers or retailers might accept lower profit margins rather than raise their prices. They are more likely to do this if demand is weak or because of competition. The degree of competition in markets can affect how much cost increases are passed on to consumers."

Investigations into what might be obstructing the flows through the inflation pipeline have taken several approaches, including the one suggested by the BOE above: Firms may vary their markups (or margins) to damp the influence of costs on prices as they pass from one stage of production to the next. This idea has become a cause célèbre in macroeconomics and a key element of something called the New Keynesian Phillips Curve.

And so we've been keeping our eyes on how our panel assesses their margins, and we note something pretty striking. That is, margins are rising, but primarily for retailers. Indeed, as our panel sees it, retail margins are getting pretty close to returning to normal. Manufacturers, however, still see their margins as well below normal.

Expanding margins, then, may slow the flow of falling commodity prices through the inflation pipeline. Manufacturers may take the fall in commodity prices as an opportunity to improve their woeful margins. And if they do pass these cost savings on down the production chain, it still might not hit consumers' wallets if retailers continue to increase their margins. (Based on our survey, that's what seems to have been going on lately, anyhow.)

For other insights from the June Business Inflation Expectation survey, see the Inflation Project on our website.

Mike BryanBy Mike Bryan, vice president and senior economist,

Laurel GraefeLaurel Graefe, economic policy analysis specialist, and

Nicholas ParkerNicholas Parker, economic research analyst, all with the Atlanta Fed

June 25, 2012 in Business Inflation Expectations, Inflation, Pricing | Permalink

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June 13, 2012


The armchair Fed historian

I enjoy researching economic history—some of my work with Steve Quinn on early central banking is here, here, and here.

The only problem with historical research, though, is that it tends to involve some real work—long hours spent with dusty archival volumes, consumption of lots of coffee and antihistamines, and a steady hand on the digital camera.

Just recently—and somewhat belatedly—I became aware of a Google application (thanks to Benjamin Guilbert's blog) that lets would-be economic historians breeze over the rough stuff and do some interesting research from their own computer keyboards. The application is called Ngrams, and here's how it works.

Basically, Ngrams counts occurrences of words in books that have been scanned by Google into its Google Books database. It then plots out the frequencies of these words as annual time series. These plots can then be used to measure how interest in a topic varies over time—to construct "cultural histories."

There are some limitations to this technique, mostly related to unavoidable issues in Google's database. For example, the dataset I chose to work with covers only English-language publications and stops in mid-2009. (See the Ngrams website for more detailed information.)

The six charts below represent a first attempt to use Ngrams to delve into the cultural history of the Federal Reserve.

Question 1: How popular is the Federal Reserve as a discussion topic compared with other central banks?

  • Search terms: Bank of England, Federal Reserve, Reichsbank, Bundesbank, Bank of Japan
  • Time period: 1900–2008


  • My interpretation: almost from its beginning in 1913, the Federal Reserve has been the primary focus of English-language writing on central banks.

Question: 2 The Fed was founded as a means to counteract banking panics. What has been the impact of the Fed on the discussion of panics?

  • Search term: bank panic
  • Time period: 1866–2008


  • My interpretation: that bank panics were widely discussed in the wake of three National Banking Era panics in 1873, 1893, and 1907, no surprise. Interest in bank panics peaked following the widespread bank failures of the early 1930s. This topic became less popular after World War II, but interest reawakened with the numerous savings and loan failures of the 1980s and early 1990s.

Question 3: One of the early policy goals of the Fed was to improve the efficiency of the check payment system. When did use of checks become the norm for ordinary Americans?

  • Search terms: pay envelope, pay check, paycheck
  • Time period: 19002008


  • My interpretation: in 1920, most people did not have checking accounts and were paid in envelopes stuffed with cash. By 1960, most households had checking accounts and were paid by "pay check," later contracted to "paycheck."

Question 4. What has been the impact of the Fed on people's concerns about inflation and unemployment?

  • Search terms: unemployment, inflation
  • Time period: 1900–2008


  • My interpretation: interest in unemployment shot up during the Great Depression, fell back in the postwar years, but resurged in the 1970s. Discussion of unemployment then falls steadily to the end of the sample in 2008. Inflation was rarely discussed until the United States left the gold standard in 1933. Interest in inflation remained below unemployment until inflation began to accelerate in the 1970s. Since about 1980, interest in these two topics has been almost identical.

Question 5: In the mind of the public, which policy goal should the Fed be most concerned with: price stability, financial stability, or employment?

  • Search terms: price stability, financial stability, Phillips curve (as an imperfect proxy for "employment"; note that the original article by William Phillips appeared in 1958)
  • Time period: 1900–2008


  • My interpretation: financial stability was paramount until after the 1951 Treasury-Fed Accord. Price stability then takes center stage until the turn of the 21st century but by 2008 had converged with financial stability. Interest in the Phillips curve seems to have peaked in the early 1980s.

Question 6: What has been the impact of two "big ideas" on monetary policy, proposed by Robert E. Lucas (1976) and John B. Taylor (1993)?

  • Search terms: Lucas critique, Taylor rule
  • Time period: 1970–2008


  • My interpretation: in his 1976 paper, Lucas argued that there were limits on the usefulness of statistical relationships (the Phillips curve in particular) in monetary policymaking. Partly in response to the Lucas critique, Taylor in 1993 proposed that central banks follow a simple rule in setting short-term interest rates. Interestingly, discussion of the Lucas critique peaked around the time of the publication of Taylor's paper. Interest in the Taylor rule was still growing at the end of the sample in 2008.

You may or may not agree with the choice of search terms or the interpretations of the search results, but you are welcome to conduct your own historical research with the same application—all from the comfort of your armchair, no digital camera required. We'll have more of these cultural histories to share in later posts.

Photo of Will RoberdsBy Will Roberds, research economist and senior policy adviser at the Atlanta Fed



June 13, 2012 in Employment, Federal Reserve and Monetary Policy, Inflation, Monetary Policy | Permalink

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That is a fantastic tool! Thanks for sharing. I especially found your search on the Lucas critique vs. Taylor rule surprising.

Posted by: Miraj Patel | June 13, 2012 at 02:24 PM

great post!

Posted by: dwb | June 13, 2012 at 06:51 PM

This is indeed a cool post. Glad that you shared this. thanks!

Posted by: business consulting | June 14, 2012 at 01:28 PM

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