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March 28, 2018
Thoughts on a Long-Run Monetary Policy Framework, Part 3: An Example of Flexible Price-Level Targeting
I want to start my discussion in this post with two points I made in the previous two macroblog posts (here and here). First, I think a commitment to delivering a relatively predictable price-level path is a desirable feature of a well-constructed monetary framework. Price stability is in my view achieved if people can have confidence that the purchasing power of the dollars they hold today will fall within a certain range at any date in the future.
My second point was that, as a matter of fact, the Federal Open Market Committee (FOMC) delivered on this definition of price stability during the years 1995–2012. (The FOMC formally adopted its 2 percent long-run inflation target in 2012.)
If you are reading this blog, you're almost certainly aware that since 2012, the actual personal consumption expenditures (PCE) inflation rate has persistently fallen short of the 2 percent goal. That, of course, means that the price level has fallen increasingly short of a reference 2 percent path, as shown in chart 1 below.
Is this deviation from the price-level path a problem? The practical answer to that question will depend on how my proposed definition of price stability is implemented.
By way of example, let's suppose that the FOMC commits to conducting monetary policy in such a way that the price level will always fall within plus-or-minus 5 percent of the long-run target path (which itself we define as the path implied by a constant 2 percent inflation rate). This policy—and how it relates to the actual path of PCE price inflation—is illustrated in chart 2.
So would inflation falling short of the 2 percent longer-run goal be a problem if the Fed was operating within the framework depicted in chart 2? In a sense, the answer is no. The current price level would be within the bounds of a hypothetical commitment made in 1995. If the central bank could perpetually deliver 2 percent annual inflation, that promise would remain intact, as shown in chart 3.
Of course, chart 3 depicts a forward path for prices whose margin for error is quite slim. Continued inflation below 2 percent would, in short order, push the price level below the lower bound, likely requiring a relatively accommodative monetary policy stance—that is, if policymakers sought to satisfy a commitment to this framework's definition of price stability.
Central bankers in risk management mode might opt for policies designed to deliberately move the price level toward the 2 percent average inflation midpoint in cases where the price level moves too close for the Committee's comfort to one of the bounds (as, perhaps, in chart 3). It bears noting that in such cases there are a wide range of options available to policymakers with respect to the timing and pace of that adjustment.
This scenario illustrates the flexibility of the price-level targeting framework I'm describing. I think it's important to think in terms of gradual adjustments that don't risk whipsawing the economy or force the central bank to be overly precise in its short-run influence on inflation and economic activity. A key feature of such a policy framework includes considerable short- and medium-run flexibility in inflation outcomes.
But the other key feature is that the framework limits that same flexibility—that is, it satisfies the principle of bounded nominal uncertainty. Suppose you and another person agree that you will receive a $1 payment in 10 years in exchange for a service provided today. If the inflation rate over this 10-year period is exactly 2 percent per year, then the real value of that dollar in goods and services would be 82 cents.
In my example (the one with a plus-or-minus 5 percent bound on the price level), monetary policymakers have essentially committed that the agreed-upon payment would not result in real purchasing power of less than 78 cents (and the payer could be confident that the real purchasing power relinquished would not be more than 86 cents).
The crux of my argument is that a "good" monetary policy framework limits the degree of uncertainty associated with contracts involving transfers of dollars over time. In limiting uncertainty, monetary policy contributes to economic efficiency.
The 5 percent bound I chose for my illustration is obviously arbitrary. The magnitude of the acceptable deviations from the price-level path would be a policy decision. I'm not sure we know a whole lot about what range of deviations from an expected price path contributes most consistently to economic efficiency. A benefit of the framework I am describing is that it would focus research, discussion, and debate squarely on that question.
This series of posts is going on hiatus for a few days. Tomorrow, the Atlanta Fed is going to release its 2017 Annual Report, and I certainly don't want to steal its thunder. And Friday, of course, will begin the Easter weekend for many people.
But I want to conclude this post by emphasizing that the framework I am describing is more of a refinement of, and not a competitor to, many of the framework proposals I discussed in Monday's post. This is an important point and one that I will turn to in the final installment of this series, to be published next Monday.
March 27, 2018
Thoughts on a Long-Run Monetary Policy Framework, Part 2: The Principle of Bounded Nominal Uncertainty
In yesterday's macroblog post, I discussed one of the central monetary policy questions of the day: Is the possibility of hitting the lower bound on policy rates likely to be an issue for the Fed going forward, do we care, and—if we do—what can we do about it?
The answers to the first questions are, in my opinion, yes and yes. That's the easy part. The last question—what can we do about it?—is the hard part. In the end, this is a question about the framework for conducting monetary policy. The menu of options includes:
- Raising the Federal Open Market Committee's (FOMC) longer-run inflation target;
- Maintaining the current policy framework, including the 2 percent longer-run inflation target, relying on unconventional tools when needed;
- Targeting the growth rate of nominal gross domestic product;
- Adopting an inflation range with flexible inflation targets that are adjusted based on the state of the economy (a relatively recent entry to the list suggested by Boston Fed president Eric Rosengren );
- Price-level targeting.
Chicago Fed president Charles Evans, San Francisco Fed president John Williams, and former Federal Reserve chairman Ben Bernanke, among others, have advocated for some version of the last item on this list of options. I am going to add myself to the list of people sympathetic to a policy framework that has a form of price-level targeting at its center.
I'll explain my sympathies by discussing principles that are central to my thinking.
First, I think the Fed's commitment to the long-run 2 percent inflation objective has served the country well. I recognize that the word “commitment” in that sentence might be more important than the specific 2 percent target value. But credibility and commitment imply objectives that, though not immutable, rarely change—and then only with a clear consensus on a better course. With respect to changing the 2 percent objective as a longer-run goal, my feet are not set in concrete, but they are in pretty thick mud.
Second, former Fed chairman Alan Greenspan offered a well-known definition of what it means for a central bank to succeed on a charge to deliver price stability. Paraphrasing, Chairman Greenspan suggested that the goal of price stability is met when households and business ignore inflation when making key economic decisions that affect their financial futures.
I agree with the Greenspan definition, and I believe that the 2 percent inflation objective has helped us meet that criterion. But I don't think we have met the Greenspan definition of price stability solely because 2 percent is a sufficiently low rate of inflation. I think it is also critical that deviations of prices away from a path implied by an average inflation rate of 2 percent have, in the United States, been relatively small.
Here's how I see it: until recently, the 2 percent inflation objective in the United States has essentially functioned as a price-level target centered on a 2 percent growth path. The orange line in the chart below shows what a price-level path of 2 percent growth would have been over the period from 1995 to 2012. I chose to begin with 1995 because it arguably began the Fed's era of inflation targeting. Why does the chart end in 2012? I'll get to that tomorrow, when I lay out a specific hypothetical plan.
The green line in the chart is the actual path of the price level, as measured by the price index for personal consumption expenditures. The chart explains what I mean when I say the FOMC effectively delivered on a 2 percent price-level target. Over the period depicted in this chart, the price level did not deviate much from the 2 percent path.
I believe the inflation outcome apparent in the chart is highly desirable. Why? Because the resulting price-level path satisfies what I will call the “principle of bounded nominal uncertainty.” In essence, the principle of bounded nominal uncertainty means that if you save a dollar today you can be “reasonably confident” about what the real value of that saving will be in the future.
For example, suppose that in January 1995 you had socked away $1 in cash that you intended to spend exactly five years later. If you believed that the Fed was going to deliver an average annual inflation rate of 2 percent over this period, you'd expect that dollar to be worth about 90 cents in real purchasing power by January 2000. (Recall that cash depreciates at the rate of inflation—I didn't say this was the best way to save!)
In fact, because the price level's realized path over that time hewed very closely to the expected 2 percent growth path, the actual value of the dollar you saved would have been very close to the 90 cents you expected. And this, I think, epitomizes a reasonable definition of price stability. If you and I enter into a contract to exchange a dollar at some future date, we can confidently predict within some range that dollar's purchasing power. Good monetary policy, in my view, will satisfy the principle of bounded nominal uncertainty.
This is the starting point of my thinking about a useful monetary policy framework—and how I think about price-level targeting generally. Tomorrow, I will expand on this thought and offer a specific example of how a price-level target might be put into operation in a way that is both flexible and respectful of the principle of bounded nominal uncertainty.
March 26, 2018
Thoughts on a Long-Run Monetary Policy Framework: Framing the Question
"Should the Fed stick with the 2 percent inflation target or rethink it?" This was the very good question posed in a special conference hosted by the Brookings Institution this past January. Over the course of roughly two decades prior to the global financial crisis, a consensus had formed among monetary-policy experts and practitioners the world over that something like 2 percent is an appropriate goal—maybe even the optimal goal—for central banks to pursue. So why reconsider that target now?
The answer to that question starts with another consensus that has emerged in the aftermath of the global financial crisis. In particular, there is now a widespread belief that, once monetary policy has fully normalized, the federal funds rate—the Federal Open Market Committee's (FOMC) reference policy rate—will settle significantly below historical norms.
Several of my colleagues have spoken cogently about this phenomenon, which is often cast in terms of concepts like r-star, the natural rate of interest, the equilibrium rate of interest, or (in the case of my colleague Jim Bullard ), r-dagger. I like to think in terms of the "neutral" rate of interest; that is, the level of the policy rate consistent with the FOMC meeting its longer-run goals of price stability and maximum sustainable growth. In other words, the level of the federal funds rate should be consistent with 2 percent inflation, the unemployment rate at its sustainable level, and real gross domestic product at its potential.
Estimates of the neutral policy rate are subject to imprecision and debate. But a reasonable notion can be gleaned from the range of projections for the long-run federal funds rate reported in the Summary of Economic Projections (SEP) released just after last week's FOMC meeting. According to the latest SEP, neutral would be in a range 2.3 to 3.0 percent.
For some historical context, in the latter half of the 1990s, as the 2 percent inflation consensus was solidifying, the neutral federal funds rate would have been pegged in a range of something like 4.0 to 5.0 percent, roughly 2 percentage points higher than the range considered to be neutral today.
The implication for monetary policy is clear. If interest rates settle at levels that are historically low, policymakers will have limited scope for cutting rates in the event of a significant economic downturn (or at least more limited scope than they had in the past). I think it's fair to say that even relatively modest downturns are likely to yield policy reactions that drive the federal funds rate to zero, as happened in the Great Recession.
My view is that the nontraditional tools deployed after December 2008, when the federal funds rate effectively fell to zero, were effective. But it is accurate to say that our experience with these tools is limited, and the effectiveness of those tools remains controversial. I join the opinion that, all else equal, it would be vastly preferable to conduct monetary policy through the time-tested approach of raising and lowering short-term policy rates, if such an approach is available.
This point is where the challenge to the 2 percent inflation target enters the picture. The neutral rate I have been describing is a nominal rate. It is roughly the sum of an inflation-adjusted real rate—determined by fundamental saving and investment decisions in the global economy—and the rate of inflation. The downward drift in the neutral rate I have been describing is attributable to a downward drift in the inflation-adjusted real rate. A great deal of research has documented this phenomenon, such as some influential research by San Francisco Fed president John Williams and Thomas Laubach, the head of the monetary division at the Fed's Board of Governors.
In the long run, a central bank cannot reliably control the real rate of interest. So if we accept the following premises...
- A neutral rate that is too low to give the central bank enough room to fight even run-of-the-mill downturns is problematic;
- Cutting rates is the optimal strategy for addressing downturns; and
- The real interest rate is beyond the control of the central bank in the long run
...then we must necessarily accept that raising the neutral rate, thus affording monetary policymakers the desired rate-cutting scope when needed, would require raising the long-run inflation rate. Hence the argument for rethinking the Fed's 2 percent inflation target.
But is that the only option? And is it the best option?
The answer to the first question is clearly no. The purpose of the Brookings Institution sessions is addressing the pros and cons of the different strategies for dealing with the low neutral rate problem, and I commend them to you. But in upcoming macroblog posts, I want to share some of my thoughts on the second question.
Tomorrow, I will review some of the proposed options and explain why I am attracted to one in particular: price-level targeting. On Wednesday, I will propose what I think is a potentially useful model for implementing a price-level targeting scheme in practice. I want to emphasize that these are preliminary thoughts, offered in the spirit of stimulating the conversation and debate. I welcome that conversation and debate and look forward to making my contribution to moving it forward.
March 23, 2018
What Are Businesses Saying about Tax Reform Now?
In a recent macroblog post, we shared some results of a joint national survey that is an ongoing collaboration between the Atlanta Fed, Nick Bloom of Stanford University, and Steve Davis of the University of Chicago, and Jose Barrero of Stanford University. (By the way, we're planning on calling this work the "Survey of Business Executives," or SBE.).
In mid-November, we posed this question to our panel of firms:
If passed in its current form, how would the Tax Cuts and Jobs Act affect your capital expenditures in 2018?
At the time, we (and perhaps others) were a little surprised to find that roughly two-thirds of respondents indicated that tax reform hasn't enticed them into changing their investment plans for 2018. Our initial interpretation was that the lack of an investment response by firms made it unlikely that we'd see a sharp acceleration in output growth in 2018.
Another interpretation of those results might be that firms were unwilling to speculate on how they'd respond to legislation that was not yet set in stone. Now that the ink has been dry on the bill for a while, we decided to ask again.
In our February survey—which was in the field from February 12 through February 23—we asked firms, "How has the recently enacted Tax Cuts and Jobs Act (TCJA) led you to revise your plans for capital expenditures in 2018?" The results shown below—restricted to the 218 firms that responded in both November 2017 and February 2018—suggest that, if anything, these firms have revised down their expectations for this year:
You may be thinking that perhaps firms had already set their capital expenditure plans for 2018, so asking about changes in firms' 2018 plans isn't too revealing—which is why we asked them about their 2019 plans as well. The results (showing all 272 responses in February) are not statistically different from their 2018 response. Roughly three-quarters of firms don't plan to change their capital expenditure plans in 2019 as a result of the TCJA:
These results contain some nuance. It seems that larger firms (those with more than 500 employees) responded more favorably to the tax reform. But it is still the case that the typical (or median) large firm has not revised its 2019 capex plans in response to tax changes.
Why the disparity between smaller and larger firms? We're not sure yet—but we have an inkling. In a separate survey we had in the field in February—the Business Inflation Expectations (BIE) survey—we asked Sixth District firms to identify their tax reporting structure and whether or not they expected to see a reduction in their tax bill as a result of the TCJA. Larger firms—which are more likely to be organized as C corporations—appear to be more sure of the TCJA's impact on their bottom lines. Conversely, smaller "pass-through" entities appear to be less certain of its impact, as shown here:
For now, we're sticking with our initial assessment that the potential for a sharp acceleration in near-term output growth is limited. However, there is some upside risk to that view if more pass-through entities start to see significantly smaller tax bills as a result of the TCJA.
March 06, 2018
A First Look at Employment
One Friday morning each month at 8:30 is always an exciting time here at the Atlanta Fed. Why, you might ask? Because that's when the U.S. Bureau of Labor Statistics (BLS) issues the newest employment and labor force statistics from the Employment Situation Summary. Just after the release, Atlanta Fed analysts compile a "first look" report based on the latest numbers. We have found this initial view to be a very useful glimpse into the broad health of the national labor market.
Because we find this report useful, we thought you might also find it of interest. To that end, we have added the Labor Report First Look tool to our website, and we'll strive to post updated data soon after the release of the BLS's Employment Situation Report. Our Labor Report First Look includes key data for the month and changes over time from both the payroll and household surveys, presented as tables and charts.
Additionally, we will also use the bureau's data to create other indicators included in the Labor Report First Look. For example, one of these is a depiction of changes in payroll employment by industry, in which we rank industry employment changes by average hourly pay levels. This tool allows us to see if payrolls are gaining or losing higher- or lower-paying jobs, as the following chart shows.
But wait, there's more! We will also report information on the so-called job finding rate—an estimate of the share of unemployed last month who are employed this month—and a broad measure of labor underutilization. Our underutilization concept is related to another statistic we created called Z-Pop, computed as the share of the population who are either unemployed or underemployed (working part-time hours but wanting full-time work) or who say they currently want a job but are not actively looking. We have found this to be a useful supplement to the BLS's employment-to-population ratio (see the chart).
The Labor Report First Look tool also allows you to dig a bit deeper into Atlanta Fed labor market analysis via links to our Human Capital Data & Tools (which includes the Wage Growth Tracker and Labor Force Dynamics web pages) and links to some of our blog posts on labor market developments and related research. (In fact, it's easy to stay informed of all Labor Report First Look updates by subscribing to our RSS feed or following the Atlanta Fed on Twitter.
We hope you'll look for the inaugural Labor Report First Look next Friday morning...we know you'll be as excited as we will!
- Young Hispanic Women Investing More in Education: Good News for Labor Force Participation
- A Different Type of Tax Reform
- X Factor: Hispanic Women Drive the Labor-Force Comeback
- Tariff Worries and U.S. Business Investment, Take Two
- Trends in Hispanic Labor Force Participation
- Quantitative Frightening?
- Are Employers Focusing More on Staff Retention?
- Defining Job Switchers in the Wage Growth Tracker
- Cryptocurrency and Central Bank E-Money
- Polarization through the Prism of the Wage Growth Tracker (Take Two)
- March 2019
- February 2019
- January 2019
- December 2018
- November 2018
- October 2018
- August 2018
- July 2018
- June 2018
- May 2018
- Business Cycles
- Business Inflation Expectations
- Capital and Investment
- Capital Markets
- Data Releases
- Economic conditions
- Economic Growth and Development
- Exchange Rates and the Dollar
- Fed Funds Futures
- Federal Debt and Deficits
- Federal Reserve and Monetary Policy
- Financial System
- Fiscal Policy
- Health Care
- Inflation Expectations
- Interest Rates
- Labor Markets
- Latin America/South America
- Monetary Policy
- Money Markets
- Real Estate
- Saving, Capital, and Investment
- Small Business
- Social Security
- This, That, and the Other
- Trade Deficit
- Wage Growth