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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.


August 12, 2014


Are We There Yet?

Editor’s note: This macroblog post was published yesterday with some content inadvertently omitted. Below is the complete post. We apologize for the error.

Anyone who has undertaken a long road trip with children will be familiar with the frequent “are we there yet?” chorus from the back seat. So, too, it might seem on the long post-2007 monetary policy road trip. When will the economy finally look like it is satisfying the Federal Open Market Committee’s (FOMC) dual mandate of price stability and full employment? The answer varies somewhat across the FOMC participants. The difference in perspectives on the distance still to travel is implicit in the range of implied liftoff dates for the FOMC’s short-term interest-rate tool in the Summary of Economic Projections (SEP).

So how might we go about assessing how close the economy truly is to meeting the FOMC’s objectives of price stability and full employment? In a speech on July 17, President James Bullard of the St. Louis Fed laid out a straightforward approach, as outlined in a press release accompanying the speech:

To measure the distance of the economy from the FOMC’s goals, Bullard used a simple function that depends on the distance of inflation from the FOMC’s long-run target and on the distance of the unemployment rate from its long-run average. This version puts equal weight on inflation and unemployment and is sometimes used to evaluate various policy options, Bullard explained.

We think that President Bullard’s quadratic-loss-function approach is a reasonable one. Chart 1 shows what you get using this approach, assuming a goal of year-over-year personal consumption expenditure inflation at 2 percent, and the headline U-3 measure of the unemployment rate at 5.4 percent. (As the U.S. Bureau of Labor Statistics defines unemployment, U-3 measures the total unemployed as a percent of the labor force.) This rate is about the midpoint of the central tendency of the FOMC’s longer-run estimate for unemployment from the June SEP.

Chart 1: Progress toward Objectives: U-3 Gap

Notice that the policy objective gap increased dramatically during the recession, but is currently at a low value that’s close to precrisis levels. On this basis, the economy has been on a long, uncomfortable trip but is getting pretty close to home. But other drivers of the monetary policy minivan may be assessing how far there is still to travel using an alternate road map to chart 1. For example, Atlanta Fed President Dennis Lockhart has highlighted the role of involuntary part-time work as a signal of slack that is not captured in the U-3 unemployment rate measure. Indeed, the last FOMC statement noted that

Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources.

So, although acknowledging the decline in U-3, the Committee is also suggesting that other labor market indicators may suggest somewhat greater residual slack in the labor market. For example, suppose we used the broader U-6 measure to compute the distance left to travel based on President Bullard’s formula. The U-6 unemployment measure counts individuals who are marginally attached to the labor force as unemployed and, importantly, also counts involuntarily part-time workers as unemployed. One simple way to incorporate the U-6 gap is to compute the average difference between U-6 and U-3 prior to 2007 (excluding the 2001 recession), which was 3.9 percent, and add that to the U-3 longer-run estimate of 5.4 percent, to give an estimate of the longer-run U-6 rate of 9.3 percent. Chart 2 shows what you get if you run the numbers through President Bullard’s formula using this U-6 adjustment (scaling the U-6 gap by the ratio of the U-3 and U-6 steady-state estimates to put it on a U-3 basis).

Chart 2: Progress toward Objectives: U-3 Gap versus U-6 Gap

What the chart says is that, up until about four years ago, it didn’t really matter at all what your preferred measure of labor market slack was; they told a similar story because they tracked each other pretty closely. But currently, your view of how close monetary policy is to its goals depends quite a bit on whether you are a fan of U-3 or of U-6—or of something in between. I think you can put the Atlanta Fed’s current position as being in that “in-between” camp, or at least not yet willing to tell the kids that home is just around the corner.

In an interview last week with the Wall Street Journal, President Lockhart effectively put some distance between his own view and those who see the economy as being close to full employment. The Journal’s Real Time Economics blog quoted Lockhart:

“I’m not ruling out” the idea the Fed may need to raise short-term interest rates earlier than many now expect, Mr. Lockhart said in an interview with The Wall Street Journal. But, at the same time, “I’m a little bit cautious” about the policy outlook, and still expect that when the first interest rate hike comes, it will likely happen somewhere in the second half of next year.

“I remain one who is looking for further validation that we are on a track that is going to make the path to our mandate objectives pretty irreversible,” Mr. Lockhart said. “It’s premature, even with the good numbers that have come in ... to draw the conclusion that we are clearly on that positive path,” he said.

Mr. Lockhart said the current unemployment rate of 6.2% will likely continue to decline and tick under 6% by the end of the year. But, he said, there remains evidence of underlying softness in the job sector, and, he also said, while inflation shows signs of firming, it remains under the Fed’s official 2% target.

Our view is that the current monetary policy journey has made considerable progress toward its objectives. But the trip is not yet complete, and the road ahead remains potentially bumpy. In the meantime, I recommend these road-trip sing-along selections.

Photo of John RobertsonBy John Robertson, a vice president and senior economist in the Atlanta Fed’s research department


August 12, 2014 in Economics, Employment, Federal Reserve and Monetary Policy, Inflation, Labor Markets, Monetary Policy, Pricing, Unemployment | Permalink

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Major problems with U6 include the fact that someone working 34 hours but wants to work 35 or more is considered unemployed (not partially unemployed) -- a very loose definition of an unemployed person. Also, some policymakers conflate marginally attached with discouraged workers. Only one-third of the marginally attached are discouraged about job prospects (the other two-thirds didn't look for work because of illness, school, etc. -- i.e., for reasons monetary policy cannot address). So there are very good reasons for President Bullard's objective function to be based on U3 rather than U6. Additionally, what policymakers should consider, to follow through with your analogy, is when you arrive at your destination should you still have the accelerator pressed to the floor? Or does it not make sense to let off of the gas a bit as you approach your destination (to avoid driving the minivan right through your home).

Posted by: Conrad DeQuadros | August 14, 2014 at 12:57 PM

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October 18, 2013


Why Was the Housing-Price Collapse So Painful? (And Why Is It Still?)

Foresight about the disaster to come was not the primary reason this year’s Nobel Prize in economics went to Robert Shiller (jointly with Eugene Fama and Lars Hansen). But Professor Shiller’s early claim that a housing-price bubble was full on, and his prediction that trouble was a-comin’, is arguably the primary source of his claim to fame in the public sphere.

Several years down the road, the causes and effects of the housing-price run-up, collapse, and ensuing financial crisis are still under the microscope. Consider, for example, this opinion by Dean Baker, co-director of the Center for Economic and Policy Research:

...the downturn is not primarily a “financial crisis.” The story of the downturn is a simple story of a collapsed housing bubble. The $8 trillion housing bubble was driving demand in the U.S. economy in the last decade until it collapsed in 2007. When the bubble burst we lost more than 4 percentage points of GDP worth of demand due to a plunge in residential construction. We lost roughly the same amount of demand due to a falloff in consumption associated with the disappearance of $8 trillion in housing wealth.

The collapse of the bubble created a hole in annual demand equal to 8 percent of GDP, which would be $1.3 trillion in today’s economy. The central problem facing the U.S., the euro zone, and the U.K. was finding ways to fill this hole.

In part, Baker’s post relates to an ongoing pundit catfight, which Baker himself concedes is fairly uninteresting. As he says, “What matters is the underlying issues of economic policy.” Agreed, and in that light I am skeptical about dismissing the centrality of the financial crisis to the story of the downturn and, perhaps more important, to the tepid recovery that has followed.

Interpreting what Baker has in mind is important, so let me start there. I have not scoured Baker’s writings for pithy hyperlinks, but I assume that his statement cited above does not deny that the immediate post-Lehman period is best characterized as a period of panic leading to severe stress in financial markets. What I read is his assertion that the basic problem—perhaps outside the crisis period in late 2008—is a rather plain-vanilla drop in wealth that has dramatically suppressed consumer demand, and with it economic growth. An assertion that the decline in wealth is what led us into the recession, is what accounts for the depth and duration of the recession, and is what’s responsible for the shallow recovery since.

With respect to the pace of recovery, evidence supports the proposition that financial crises without housing busts are not so unique—or if they are, the data tend to associate financial-related downturns with stronger-than-average recoveries. Mike Bordo and Joe Haubrich, respectively from Rutgers University and the Federal Reserve Bank of Cleveland, argue that the historical record of U.S. recessions leads us to view housing and the pace of residential investment as the key to whether tepid recoveries will follow sharp recessions:

Our analysis of the data shows that steep expansions tend to follow deep contractions, though this depends heavily on when the recovery is measured. In contrast to much conventional wisdom, the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis. In fact, on average, it is cycles without a financial crisis that show the weakest relation between contraction depth and recovery strength. For many configurations, the evidence for a robust bounce-back is stronger for cycles with financial crises than those without...

Our results also suggest that a sizeable fraction of the shortfall of the present recovery from the average experience of recoveries after deep recessions is due to the collapse of residential investment.

From here, however, it gets trickier to reach conclusions about why changes in housing values are so important. Simply put, why should there be a “wealth effect” at all? If the price of my house falls and I suffer a capital loss, I do in fact feel less wealthy. But all potential buyers of my house just gained the opportunity to obtain my house at a lower price. For them, the implied wealth gain is the same as my loss. If buyers and sellers essentially behave the same way, why should there be a large impact on consumption? *

I think this notion quickly leads you to the thought there is something fundamentally special about housing assets and that this special role relates to credit markets and finance. This angle is clearly articulated in these passages from a Bloomberg piece earlier in the year, one of a spate of articles in the spring about why rapidly recovering house prices were apparently not driving the recovery into a higher gear:

The wealth effect from rising house prices may not be as effective as it once was in spurring the U.S. economy...

The wealth effect “is much smaller,” said Amir Sufi, professor of finance at the University of Chicago Booth School of Business. Sufi, who participated in last year’s central-bank conference at Jackson Hole, Wyoming, reckons that each dollar increase in housing wealth may yield as little as an extra cent in spending. That compares with a 3-to-5-cent estimate by economists prior to the recession.

Many homeowners are finding they can’t refinance their mortgages because banks have tightened credit conditions so much they’re not eligible for new loans. Most who can refinance are opting not to withdraw equity after the first nationwide decline in house prices since the Great Depression reminded them home values can fall as well as rise...

Others are finding it difficult to refinance because credit has become a lot harder to come by. And that situation could worsen as banks respond to stepped-up government oversight.

“Credit is going to get tighter before it gets easier,” said David Stevens, president and chief executive officer of the Washington-based Mortgage Bankers Association...

“Households that have been through foreclosure or have underwater mortgages or are otherwise credit-constrained are less able than other households to take advantage” of low interest rates, Fed Governor Sarah Bloom Raskin said in an April 18 speech in New York.

(I should note that Sufi et al. previously delved into the relationship between household balance sheets and the economic downturn here.)

A more systematic take comes from the Federal Reserve Board’s Matteo Iacoviello:

Empirically, housing wealth and consumption tend to move together: this could happen because some third factor moves both variables, or because there is a more direct effect going from one variable to the other. Studies based on time-series data, on panel data and on more detailed, recent micro data point suggest that a considerable portion of the effect of housing wealth on consumption reflects the influence of changes in housing wealth on borrowing against such wealth.

That sounds like a financial problem to me and, in the spirit of Baker’s plea that it is the policy that matters, this distinction is more than semantic. The policy implications of an economic shock that alters the capacity to engage in borrowing and lending are not necessarily the same as those that result from a straightforward decline in wealth.

Having said that, it is not so clear how the policy implications are different. One possibility is that diminished access to credit markets also weakens policy-transmission mechanisms, calling for even more aggressive demand-oriented “pump-priming” policies of the sort Dean Baker advocates. But it is also possible that we have entered a period of deep structural repair that only time (and not merely government stimulus) can (or should) engineer: deleveraging and balance sheet repair, sectoral resource reallocation, new consumption habits, new business models driven by both market and regulatory imperatives, you name it.

In my view, it’s not yet clear which policy approach is closest to optimal. But I am fairly well convinced that good judgment will require us to think of the past decade as the financial event it was, and in many ways still is.

*Update: A colleague pointed out that my example describing housing price changes and wealth effects may be simplified to the point of being misleading. Implicitly, I am in fact assuming that the flow of housing services derived from housing assets is fixed, a condition that obviously would not hold in general. See section 3 of the Iacoviello paper cited above for a theoretical description of why, to a first approximation, we would not expect there to be a large consumption effect from changes in housing values.

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


October 18, 2013 in Economic conditions, Housing, Pricing, Real Estate | Permalink

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A primary residence's home price reflects the economic value to a homeowner of living in an area. The major part of the economic value of living somewhere is future expected earnings. The home price will not exceed the economic value to the marginal buyer. When expectations of future earnings decline home prices will decline across the board.

Using housing wealth is just intertemporal substitution. Refinancing is self-financing with homeowners self-qualifying themselves for the mortgage debt. Bank restrictions can limit refinancing but most homeowners will not refinance if they belive they cannot afford to repay the debt or sell above mortgage amounts.

Home price appreciation and the ability to pay back the refinancing or first mortgage debt depend on expectations of a continuation of wage growth to the borrower, or future homebuyer (if one expects to sell prior to debt payoff). A decline in expected wage growth rates (productivity) will cause home prices to decline, unemployment to increase and wages to stagnate.

Wage and GDP growth are linked to capital investment and there has been a sharp decline in US capital investment, which is continuing. If the decrease in capital investment was anticipated (expected), then whatever shock caused the decline in investment is also causing the continuing slow recovering.

Home price decline and the continuing slow recovery have common causes.

Posted by: Milton Recht | October 18, 2013 at 06:24 PM

For those of us between 20-40, first time buyers or up-graders, high land/building prices are very much a drag on our budget. This also includes high rents for the businesses we are starting.

My parents were able to buy their first house in their early twenties on a single blue collar income with a 40% down payment that took only a few years to accumulate. That seems utterly utopian among my peers.

In the long term, high housing prices is a drag on the economy. Do high gasoline prices help people because they feel their cars' tank is worth more?

The only people benefiting from rising house prices are people speculating, those who buy or build with the intent to sell.

Posted by: Benoit Essiambre | October 19, 2013 at 08:45 AM

Mr. Altig, the reason housing mattered so much in the late 2000s, and more than it had in previous times, was precisely because the housing "wealth effect" was just about the only thing normal people had going for them.

While wealth seemed to be increasing in the financial sector, much of that, as we learned, was piggy-backed on the notion that houses would always increase in value--and on the widespread idea that any loan was a good loan because you could bundle it and sell it off.

Much of the rest of the country's GDP improvements came in tech, but tech lately tends to destroy the wealth of everyday people as it automates and outsources their jobs.

That's why the late 1990s/early 2000s real estate boom needs to be seen as a response to a fading job market. The end of job security and the ever-declining wages for ordinary workers meant millions of people taking up the business of flipping houses.

The bubble's runup cannot be understood except in this context. Most people did not want to become mortgage fraudsters. But economic circumstances changed to make house-flipping and mortgage fraud the most (and mostly the only) lucrative option for people who used to be bank tellers and salesmen and low-level software developers.

And right: there has as yet been no policy changes designed to either increase wages or create honest jobs for everyday people. Absent action on this concern, the only question before us is, What will bubble next?

Posted by: Edward Ericson Jr. | October 21, 2013 at 03:35 PM

A couple of issues not mentioned abut the "wealth effect":

During the bubble, many folks bought houses with little or no downpayment. Many bought houses with loans that were not really affordable for them in the long term because of the terms of the loan or the because the actual issuance of the loan was, shall we say, irregular. So when rates rose or prices went down, they had no buffer.

Many who had houses they could afford or even paid off took the wealth effect somewhat literally and spent it, in the form of equity loans, thanks to the same low rate, loose terms, and irregularities. The "wealth" they had just spent turned out to be a short-lived ephemeral delusion, but the debt was durable.

Posted by: MacCruiskeen | October 22, 2013 at 07:24 AM

During the peak of the housing bubble, consumers were taking out $100B/month in new debt:

http://research.stlouisfed.org/fred2/graph/?g=nG5

I find it stunning that people still don't understand this basic aspect of the reality of the erstwhile "Bush Boom".

It was all borrowed money! Trillions! Flowing to millions of households, and creating millions of jobs via this stealth stimulus.

But it was all ponzi-based, as the specuvesting was being supported by more and more "suicide" lending products and outright fraud at all levels of the FIRE sector, from customer-facing brokers to the ratings agencies stamping AAA on CDOs.

What got the housing appreciation train going in 2002 was Greenspan's lower interest rates and the 2001-2003 tax cuts, which empowered homebuyers to bid up the cost of housing more.

Momentum kept the game going in 2004, but the smart money started getting out in 2005, leaving the field to idiots stampeded into buying then or being priced out forever (plus millions of specuvestors like Casey Serin playing with OPM).

Drop $100B/month onto the middle class again and we'd have a helluva great economy again, like we did in 2004-2005.

Posted by: Troy | October 23, 2013 at 10:01 PM

Don't forget the fraudulent nature of the house price increases in much of the country.

In many many places, loans were issued and properties flipped because lenders and/or borrowers were blatantly writing fraudulent loan paperwork. Prices were inflated above sustainable economic value as a result. Those who sold received ill-gotten gains; those who bought and held were forced to pay higher prices than they should have - they were robbed. Those who flipped paper received ill-gotten gains; those who bought the AAA-rated bonds and didn't get their interest or principal back were robbed. Those who borrowed against the higher, fraudulent prices, thinking that rising prosperity and declining rates would make refinancing later affordable, were tricked too. In fact, never in the course of human events have so many been robbed so badly, by so few.

Wondering why the eventual collapse was so painful is a ludicrous pastime for "economists". The net worth of the overwhelming majority of Americans is entirely in their home equity. Or was. Many folks lost their entire net worth. Rebuilding that takes time in the best of circumstances, and even more so now, given the structural problems in the economy. Furthermore, many of these folks were burned so badly that they will refuse to partake in a repeat.

The Federal Reserve, among many other institutions, was AWOL when it should have been regulating to prevent all of this. Greenspan is recently on record claiming that fraud is a law-enforcement issue, not a Federal Reserve issue. That is nonfeasance. The Fed has regulatory powers and anything that leads to "bezzle" on the balance sheets (to borrow a term from J.K. Galbraith) is also a regulatory issue because it means banks haven't got the capital base they claim to have. There was plenty of evidence available to those willing to look for it.

I suspect that 100 years from now, History is not going to look kindly on anything the Fed did from about 2002-present.

Posted by: Sustainable Gains | October 24, 2013 at 12:18 AM

You should look at Richard Koo's work on balance sheet recessions to get an understanding of the dynamic.

Simply put, if a household or business owns assets financed by debt,and that asset has declined in value, the household reduces consumption and increases savings/reduces debt to reduce the risk of default.

It is important to understand because debt is reduced under these circumstances irrespective of the interest rate.

Posted by: RichL | October 24, 2013 at 04:43 PM

Here's a table, compiled by former Fed Governor Larry Lindsey, that explains much of the pain from the housing-bubble collapse. The lower 75% of households (by wealth) have still not recovered their peak wealth.

http://www.portphillippublishing.com.au/DR20131118c.jpg

This is consistent with what I wrote above; glad to see someone with the right background is looking into this.

Too bad it's too late; the next bubble is already upon us, and no one in a position of authority was willing to take away the punchbowl early enough.

Posted by: Sustainable Gains | November 18, 2013 at 02:43 PM

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July 16, 2013


Commodity Prices and Inflation: The Perspective of Firms

We’ve been thinking a lot about commodity prices lately. In case you haven’t noticed, they’ve been falling. And with inflation already tracking well under the Federal Open Market Committee’s (FOMC) longer-term objective of 2 percent, it’s reasonable to wonder whether the modest downward tilt in commodity prices is likely to put even more, presumably unwanted, disinflation into the pipeline.

We take some comfort from research by Chicago Fed President Charles Evans and coauthor Jonas Fisher, vice president and macroeconomist, also of the Chicago Fed. They conducted a statistical analysis of commodity prices and core inflation and found no meaningful relationship between the two in the post-Volcker era of the Fed. According to the authors,

[I]f commodity and energy prices were to lead to a general expectation of a broader increase in inflation, more substantial policy rate increases would be justified. But assuming there is a generally high degree of central-bank credibility, there is no reason for such expectations to develop—in fact, in the post-Volcker period, there have been no signs that they typically do.

We took this bit of good news to our boss here at the Atlanta Fed, Dennis Lockhart, who hit us with a question we wish we had thought to ask. To paraphrase: Is the response of inflation different for commodity price increases compared to commodity price decreases? The idea here is that, for a time at least, firms will pass commodity price increases on to their customers but simply enjoy higher margins when commodity prices decline.

So we reached out to our business inflation expectations (BIE) survey panel and put the question to them. Of the 209 firms who responded to the survey in July, half were asked how they would likely respond to an unexpected 10 percent increase in the costs of raw materials, and the other half were asked how they would likely respond to an unexpected 10 percent decrease. What we learned was that the boss was on to something.

For the half of the panel given the raw materials cost increase, about 52 percent indicated they would mostly push the materials costs on to their customers in the form of higher prices, compared to only 18 percent who indicated they would decrease their margins. But of the half of our sample that was given a decline in raw materials costs, 43 percent indicated they would mostly take their good fortune in the form of better margins and only 25 percent indicated that the drop in raw materials costs would induce them to drop their prices.

Of course, what a firm thinks it will do and what the marketplace will allow are not necessarily the same. But this got us thinking back to the earlier work at the Chicago Fed. Does this sort of “asymmetric” response to commodity prices appear in the data?

Following (roughly) the procedure that Evans and Fisher used, we computed the influence of a positive “shock” of one standard deviation (about 5 percent) to commodity prices on core inflation. (Our sample runs from 1954 to 2013.) As did Evans and Fisher, we confirmed that commodity price increases had a significant positive influence on core inflation, spread out over a period of several years. But we were surprised to see that when businesses were hit with a similar-sized decrease in commodities prices, the opposite didn’t occur. Commodity price declines did not produce any downward pressure on core inflation.

As in Evans and Fisher, focusing in on just the post-Volcker era (from 1982 forward), we found that the influence of positive commodity price increases on core inflation was significantly diminished (although it appears to be just a little stronger than what they had reported). However, the influence of commodity price decreases on core inflation remained the same—nada.

For many of you, this result probably doesn’t strike you as pathbreaking. There are many macroeconomic models where prices are “sticky” going down but pretty flexible on the way up. But if the question is whether we think the recent slide in commodity prices is likely to put added downward pressure on core inflation, we’re likely to echo Evans and Fisher with a bit more emphasis: the decline in commodity prices isn’t likely to have an influence on core inflation unless it leads to a general expectation of a broader disinflation. And there is no evidence in the data that suggests this is likely—post-Volcker era or not.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist,

Photo of Brent MeyerBrent Meyer, economist, and

Photo of Nicholas ParkerNicholas Parker, senior economic research analyst, all in the Atlanta Fed's research department


July 16, 2013 in Business Inflation Expectations, Inflation, Pricing | Permalink

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Good analysis.

Does this same dynamic apply to wages? Recent trends in real wages and corporate profits support the idea that when wages fall, firms use it to expand margins. So if we ever get wages to rise again in line with productivity, maybe we'll see firms pass on the costs to their customers. In a consumer-driven economy, wouldn't this create a self-reinforcing cycle of economic growth?

Posted by: Tom in Wisconsin | July 17, 2013 at 10:47 PM

Ha Ha! Tom! Good one!

Dude, increasing wages is the very definition of inflation!

lol!

As for Mr. Bryan's analysis: really, who did not already know this, but for him & a few others at the Atlanta Fed?

Posted by: Edward Ericson Jr. | July 28, 2013 at 08:40 AM

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July 08, 2013


Let’s Talk about Oil

Given its role in touching nearly every aspect of life across the globe and given the higher and volatile prices over the past half-decade, oil supply has been an incessant topic of conversation for much of our recent memory. Yet the tone of the conversation has dramatically pivoted recently from arguments about whether peak oil or sky-high oil prices could spur a global economic meltdown (anyone remember 2008?) to the shifting energy balance as a result of rapidly growing oil production from North America.

Chip Cummins and Russell Gold recently published a piece in the Wall Street Journal discussing how new supply from U.S. shale oil and Canadian oil sands is helping to steady global oil prices.

Crude prices have remained remarkably stable over the past year in the face of a long list of supply disruptions, from Nigerian oil theft to Syrian civil war to an export standoff between Sudan and South Sudan. The reason in large part is a thick new blanket of North American oil cushioning the markets.

This chart helps demonstrate how quickly the oil landscape in the United States has indeed changed. The U.S. Energy Information Administration (EIA) expects national crude oil production to exceed net oil imports later this year, marking a rapid turnaround from the trend of ever-increasing reliance on imports.



However, despite the increase in U.S. oil production, global oil prices have stabilized at relatively high levels, as the chart below shows.



However, the two seemingly opposing narratives—that of high oil prices and that of an emerging oil and gas abundance—are fundamentally linked. In fact, if it hadn’t been for such high oil prices, this new surge in North American oil production may not have happened. It is much more difficult to rationalize drilling activity in deep offshore areas, hard shale, or tar sands—from which, by nature, oil is expensive to produce—without high oil prices. (West Texas Intermediate, or WTI, oil averaged $31 per barrel in 2003, which, even in real terms, is only about 2/5 of today’s prices.) Analysts at Morgan Stanley estimate that the break-even point for Bakken (North Dakota) crude oil is about $70 per barrel and that even a price of $85 per barrel could squeeze out many of the unconventional producers.

What does all this mean for prices? Well, keep in mind that oil is a global commodity. So the roughly two million barrels of oil per day that have entered the market from the U.S. fracking boom represent a big shift domestically but only just over 2 percent of global oil consumption.

And while the United States is seeing growing oil supplies and moderating demand, a different trend is taking place globally, with rising demand from China and other emerging economies coupled with declining supply from older fields and OPEC efforts to keep prices higher through production limits.

However, not everyone believes that higher prices are here to stay. Some analysts have begun to warn that a price crash may be looming. Paul Stevens, an energy specialist with Chatham House, argues that we may be headed for a replay of the price crash in 1986 when high prices triggered demand destruction while bringing new, more expensive sources of supply to the market from the North Sea and Alaska.

Only time will tell where global oil prices will ultimately shake out, but for now, the larger supply cushion has certainly been a welcome development in the United States. Back to the Wall Street Journal article:

The new supply...is acting as a shock absorber in a global supply chain that pumps 88 million barrels of oil to consumers each day. That helps everyone from manufacturers to motorists, by steadying fuel prices and making budgeting easier.

Photo of Laurel GraefeBy Laurel Graefe, Atlanta Fed REIN director, and

Photo of LRebekah DurhamRebekah Durham, economic policy analysis specialist at the New Orleans Branch of the Atlanta Fed

Authors’ note: We didn’t touch on the difference between WTI and Brent oil prices in this post, despite the fact that the changing global oil production landscape has undoubtedly contributed to that spread. For those interested, we recommend some recent analysis from the Energy Information Administration on the narrowing spread between WTI and Brent.


July 8, 2013 in Economics, Energy, Pricing | Permalink

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A useful distinction is between the equilibrium price and the spot price which is notoriously volatile, in part, because of geopolitical risks in the Middle East. Increased production sourced in N. America reduces those risks and by adding 'spare capacity' also reduces overall costs by obviating the need for contingency arrangements.

Posted by: van schayk | July 09, 2013 at 12:42 PM

You only briefly mention moderating demand in the US, but the change in demand is about the same as the change in supply (US production). There has been lots of talk about increased production, but very little at the decreased domestic demand. Some of this is due to decreased miles driven, while some is due to higher CAFE standards prompting many new models to have significantly higher mileage than prior models (20% better for Altimas, Mazdas & others). Increased production is important, but reduced demand is equally important, and will be a better long-term solution as we will continue to see improvements as the nationwide fleet improves its mileage.

http://www.eia.gov/countries/country-data.cfm?fips=US#pet

Posted by: JimC | July 10, 2013 at 09:48 AM

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May 16, 2013


Labor Costs, Inflation Expectations, and the Affordable Care Act: What Businesses Are Telling Us

The Atlanta Fed’s May survey of businesses showed little overall concern about near-term inflation. Year-ahead unit cost expectations averaged 2 percent, down a tenth from April and on par with business inflation expectations at this time last year.

OK, we’re going to guess this observation doesn’t exactly knock you off your chair. But here’s something we’ve been keeping an eye on that you might find interesting. When we ask firms about what role, if any, labor costs are likely to play in their prices over the next 12 months, an increasing proportion have been telling us they see a potential for upward price pressure coming from labor costs (see the chart).



To investigate further, we posed a special question to our Business Inflation Expectations (BIE) panel regarding their expectations for compensation growth over the next 12 months: “Projecting ahead over the next 12 months, by roughly what percentage do you expect your firm’s average compensation per worker (including benefits) to change?”

We got a pretty large range of responses, but on average, firms told us they expect average compensation growth—including benefits—of 2.8 percent. That’s about a percent higher than the average over the past year (as estimated by either the index of compensation per hour or the employment cost index). But a 2.8 percent rise is also about a percentage point below average compensation growth before the recession. We’re included to read the survey as a confirmation that labor markets are improving and expected to improve further over the coming year. But we’re not inclined to interpret the survey data as an indication that the labor market is nearing full employment.

We’ve also been hearing more lately about the potential for the Affordable Care Act (ACA) to have a significant influence on labor costs and, presumably, to provide some upward price pressure. Indeed, several of our panelists commented on their concern about the influence of the ACA when they completed their May BIE survey. So can we tie any of this expected compensation growth to the ACA, a significant share of which is scheduled to go into effect eight months from now?

Because a disproportionate impact from the ACA will fall on firms that employ 50 or more workers, we separated our panel into firms with 50 or more employees, and those employing fewer than 50 workers. What we see is that average expected compensation growth is the same for the bigger employers and smaller employers. Moreover, the big firms in our sample report the same inflation expectation as the smaller firms.

But the data reveal that the bigger firms are a little more uncertain about their unit cost projections for the year ahead. OK, it’s not a big difference, but it is statistically significant. So while their cost and compensation expectations are not yet being affected by the prospect of the ACA, the act might be influencing their uncertainty about those potential costs.



Photo of Mike BryanBy Mike Bryan, vice president and senior economist,

Photo of Brent MeyerBrent Meyer, economist, and

Photo of Nicholas ParkerNicholas Parker, senior economic research analyst, all in the Atlanta Fed’s research department


May 16, 2013 in Business Inflation Expectations, Economics, Health Care, Inflation Expectations, Labor Markets, Pricing | Permalink

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Maybe we're finally reaching the point where firms can no longer expropriate productivity gains. If you look at the total hourly compensation for non-supervisory workers vs. productivity, the last 40 years have more or less seen the gains made during the Great Compression utterly obliterated. Now that we're back to Gilded-Age levels of income distribution, it may be that we've reached an equilibrium.

Posted by: Valerie Keefe | May 19, 2013 at 12:22 PM

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May 09, 2013


Weighing In on the Recent Discrepancy in the Inflation Statistics

Recently, there has been a divergence between inflation as measured by the Consumer Price Index (CPI) and the preferred inflation measure of the Federal Open Market Committee (FOMC), which is the price index for personal consumption expenditures (PCE). That divergence is fairly evident in the “core” measures of these two price statistics shown in the chart below.

This strikes us (and others, like Reuters’ Pedro da Costa) as a pretty significant development. The core CPI is telling us that the underlying inflation trend is still holding reasonably close to the FOMC’s longer-term target of 2 percent. But the behavior of the core PCE is rather reminiscent of 2010, when the inflation statistics slid to uncomfortably low levels—a contributing factor to the FOMC’s adoption of QE2. Which of these inflation statistics are we to believe?

Part of the divergence between the two inflation measures is due to rents. Rents are rising at a good pace right now, and since it’s pretty clear that the CPI over-weights their influence, we might be inclined to dismiss some part of the CPI’s more elevated signal. But then there are all those “non-market” components that have been pulling the PCE inflation measure lower—and these aren’t in the CPI. These are components of the PCE price index for which there are no clearly observable transaction prices. They include the “cost” of services provided to households by nonprofit organizations, or the benefits households receive that can only be imputed (i.e., that “free” checking account your bank provides if you maintain a high balance.) Since we can’t really observe the price of these things, we’d probably be inclined to dismiss their influence on PCE the inflation measure. But we’ve done the math, and the impact of these two influences accounts for only about a third of the recent gap between the core PCE and the core CPI inflation measures. Most of the disagreement between the two inflation estimates is coming from elsewhere.

We could continue to parse, item by item, all the various components and weights of the two statistics to get to the bottom of this discrepancy. But in the end, such an accounting exercise would merely tell us why the gap between the two measures has emerged, not which measure is giving the best signal of emerging inflation trends.

As an alternative approach, we thought we’d let the data speak for themselves and search for a common trend that runs through the detailed price data. What we have in mind is to compute the “first principal component” of the disaggregated data used to calculate the CPI and the PCE price indexes. The first principal component is a weighting of the data that explains as much of the data variation as possible. So, in effect, the detailed price data in each price index are being reweighted in a way that reveals their most commonly shared trend, and not by their share of consumer expenditure.

The chart below shows the 12-month trend of the first principal component derived from the 45 CPI components used in the computation of the Federal Reserve Bank of Cleveland’s median CPI, and the first principal component derived from the 177 components used in the computation of the Federal Reserve Bank of Dallas’s trimmed-mean PCE. (These are the most detailed component price data we could easily get our hands on.)

So what do we make of this picture? Well, three things:

First, inflation as measured by the PCE price index has tended to track about 0.25 percentage point under inflation as measured by the CPI over time. So part of the gap between the two inflation measures appears to be a long-term feature of the two inflation statistics.

Second, the first principal components of both the CPI and the PCE data have been persistently under their precrisis averages. In the case of the PCE measure, the first principal component is under the FOMC’s 2 percent target (a point that has not gone unnoticed by Paul Krugman).

A third takeaway from the chart is that the “disinflation” pattern traced out by these principal components has been gradual and modest—much more so than what the core PCE has recently indicated and what the data were telling us back in 2010.

Does that mean we should ignore the recent disinflation being exhibited in the core PCE inflation measure? Well, let’s put it this way: If you’re a glass-half-full sort, we’d say that the recent disinflation trend exhibited by the PCE price index doesn’t seem to be “woven” into the detailed price data, and it certainly doesn’t look like what we saw in 2010. But to you glass-half-empty types, we’d also point out that getting the inflation trend up to 2 percent is proving to be a curiously difficult task.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist,

Photo of Pat HigginsPat Higgins, economist,

Photo of Brent MeyerBrent Meyer, economist, and

Photo of Nicholas ParkerNicholas Parker, senior economic research analyst, all in the Atlanta Fed’s research department


May 9, 2013 in Business Inflation Expectations, Economics, Inflation, Pricing | Permalink

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No, the correct takeaway is the the focus should be on nominal gdp, which is the number that we know with significantly more certainty. There is no single explanation for why CPI, the GDP deflator, and PCE diverge (the principal components are not likely to be stable through time). Sometimes the answer is rents, sometimes its import prices, sometimes the answer is the various weights. all of the above.

Posted by: dwb | May 10, 2013 at 09:48 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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