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March 23, 2020
American Firms Foresee a Huge Negative Impact of the Coronavirus
The rapid unfolding of the COVID-19 pandemic has created grave concerns for the health and welfare of the U.S. population and the economy. The economic worries are very apparent in financial markets. From the closing bell on February 21 through March 20, U.S. equities fell more than 30 percent, and stock market volatility skyrocketed.
At present, we simply don't know the extent of the overall disruption to the economy. We are still months away from confidently gauging COVID-19's impact on output growth. However, the latest wave of results from our Survey of Business Uncertainty (SBU) indicates that firms are bracing for a huge negative impact on their businesses. Our results also say the outlook deteriorated rapidly over the past two weeks.
The SBU was in the field from March 9 until last Friday, March 20. Relative to February, firms' four-quarter-ahead sales growth expectations fell sharply, from above 5 percent to below zero. This fall is, by far, the starkest one-month swing we've recorded since the inception of the SBU in October 2014. In addition, firms' uncertainty about their own sales growth rates rose 44 percent from February to March (see exhibit 1).
Interestingly, SBU respondents did not report a material softening in the outlook for employment growth during the next 12 months, or in the capital investment rate four quarters hence. However, given the latest signals from the labor market—most notably, last Thursday's initial unemployment claims report—employment is set to contract sharply for at least a few weeks. Perhaps respondent firms see the coronavirus impact as sharp but short-lived, with little impact on longer-term employment and plans for capital expenditure.
To better gauge how firms see the direct impact of COVID-19 on their sales outlook, the March SBU included the following special question: “What is your best guess for the impact of coronavirus developments on your firm's sales revenue in 2020?” Exhibit 2 summarizes the results.
Pooling responses over the survey's full two weeks in the field, firms anticipate revenue losses of more than 6 percent in 2020 as a result of coronavirus-related disruptions. Perhaps even more telling is how the responses evolved over the two-week period. As the virus spread—and as companies, households, and governments reacted—the collective judgment of responding firms about the severity of the negative hit to sales more than doubled.
In the first week, roughly two thirds of firms said coronavirus-related developments would harm their sales in 2020. Among those affected, the average expected decline was 9 percent. In the second week, nearly 85 percent said coronavirus-related developments would negatively affect their sales, with an average decline of 16 percent among affected firms—making it clear that from one week to the next, both the reach and severity of the anticipated impact rose sharply.
Exhibit 3 breaks down anticipated effects by major industry sector and shows that no sector is immune to the disruptive effects surrounding the virus and efforts to restrain its spread.
In sum, our March survey results show a very large and very negative impact on sales. Our direct question about coronavirus's anticipated impact on the sales outlook (exhibit 2) and the deterioration in the outlook from February to March (exhibit 1) suggest that recent events will lower sales by 6 percent or more. At this point, though, anticipating a sales decline of 6 percent might be too optimistic, for two reasons. First, the anticipated coronavirus impact intensified greatly from the first week to the second week of our March survey. Second, the virus continues a rapid spread domestically and abroad, prompting governments to respond with tighter travel restrictions and stricter social distancing policies.
October 26, 2018
On Maximizing Employment, a Case for Caution
Over the past few months, I have been asked one question regularly: Why is the Fed removing monetary policy stimulus when there is little sign that inflation has run amok and threatens to undermine economic growth? This is a good question, and it speaks to a philosophy of how to maintain the stability of both economic performance and prices, which I view as important for the effective implementation of monetary policy.
In assessing the degree to which the Fed is achieving the congressional mandate of price stability, the Federal Open Market Committee (FOMC) identified 2 percent inflation in consumption prices as a benchmark—see here for more details. Based on currently available data, it seems that inflation is running close to this benchmark.
The Fed's other mandate from Congress is to foster maximum employment. A key metric for performance relative to that mandate is the official unemployment rate. So, when some people ask why the FOMC is reducing monetary policy stimulus in the absence of clear inflationary pressure, what they really might be thinking is, "Why doesn't the Fed just conduct monetary policy to help the unemployment rate go as low as physically possible? Isn't this by definition the representation of maximum employment?"
While this is indeed one definition of full employment, I think this is a somewhat short-sighted perspective that doesn't ultimately serve the economy and American workers well. One important reason for being skeptical of this view is our nation's past experience with "high-pressure" economic periods. High-pressure periods are typically defined as periods in which the unemployment rate falls below the so-called natural rate—using an estimate of the natural rate, such as the one produced by the Congressional Budget Office (CBO).
As the CBO defines it, the natural rate is "the unemployment rate that arises from all sources other than fluctuations in demand associated with business cycles." These "other sources" include frictions like the time it takes people to find a job or frictions that result from a mismatch between the set of skills workers currently possess and the set of skills employers want to find.
When the actual unemployment rate declines substantially below the natural rate—highlighted as the red areas in the following chart—the economy has moved into a "high-pressure period."
For the purposes of this discussion, the important thing about high-pressure economies is that, virtually without exception, they are followed by a recession. Why? Well, as I described in a recent speech:
"One view is that it is because monetary policy tends to take on a much more 'muscular' stance—some might say too muscular—at the end of these high-pressure periods to combat rising nominal pressures.
"The other alternative is that the economy destabilizes when it pushes beyond its natural potential. These high-pressure periods lead to a buildup of competitive excesses, misdirected investment, and an inefficient allocation of societal resources. A recession naturally results and is needed to undo all the inefficiencies that have built up during the high-pressure period.
"Yet, some people suggest that deliberately running these high-pressure periods can improve outcomes for workers in communities who have been less attached to the labor market, such as minorities, those with lower incomes, and those living in rural communities. These workers have long had higher unemployment rates than other workers, and they are often the last to benefit from periods of extended economic growth.
"For example, the gap between the unemployment rates of minority and white workers narrows as recoveries endure. So, the argument goes, allowing the economy to run further and longer into these red areas on the chart provides a net benefit to these under-attached communities.
"But the key question isn't whether the high-pressure economy brings new people from disadvantaged groups into the labor market. Rather, the right question is whether these benefits are durable in the face of the recession that appears to inevitably follow.
"This question was explored in a research paper by Atlanta Fed economist Julie Hotchkiss and her research colleague Robert Moore. Unfortunately, they found that while workers in these aforementioned communities tend to experience greater benefits from these high-pressure periods, the pain and dislocation associated with the aftermath of the subsequent recession is just as significant, if not more so.
"Importantly, this research tells me we ought to guard against letting the economy slip too far into these high-pressure periods that ultimately impose heavy costs on many people across the economy. Facilitating a prolonged period of low—and sustainable—unemployment rates is a far more beneficial approach."
In short, I conclude that the pain inflicted from shifting from a high-pressure to a low-pressure economy is too great, and this tells me that it is important for the Fed to beware the potential for the economy overheating.
Formulating monetary policy would all be a lot easier, of course, if we were certain about the actual natural rate of unemployment. But we are not. The CBO has an estimate—currently 4.5 percent. The FOMC produces projections, and other forecasters produce estimates of what it thinks the unemployment rate would be over the longer run.
For my part, I estimate that the natural rate is closer to 4 percent, and given the current absence of accelerating inflationary pressures, we can't completely dismiss the possibility that the natural rate is even lower. Nonetheless, with the unemployment rate currently at 3.7 percent, it seems likely that we're at least at our full employment mandate.
So, what is this policymaker to do? Back to my speech:
"My thinking will be informed by the evolution of the incoming data and from what I'm able to glean from my business contacts. And while I wrestle with that choice, one thing seems clear: there is little reason to keep our foot on the gas pedal."
August 23, 2018
What Does the Current Slope of the Yield Curve Tell Us?
As I make the rounds throughout the Sixth District, one of the most common questions I get these days is how Federal Open Market Committee (FOMC) participants interpret the flattening of the yield curve. I, of course, do not speak for the FOMC, but as the minutes from recent meetings indicate, the Committee has indeed spent some time discussing various views on this topic. In this blog post, I'll share some of my thoughts on the framework I use for interpreting the yield curve and what I'll be watching. Of course, these are my views alone and do not reflect the views of any other Federal Reserve official.
Many observers see a downward-sloping, or "inverted," yield curve as a reliable predictor for a recession. Chart 1 shows the yield curve's slope—specifically, the difference between the interest rates paid on 10-year and 2-year Treasury securities—is currently around 20 basis points. This is lowest spread since the last recession.
The case for worrying about yield-curve flattening is apparent in the chart. The shaded bars represent recessionary periods. Both of the last two recessions were preceded by a flat (and, for a time, inverted) 10-year/2-year spread.
As we all know, however, correlation does not imply causality. This is a particularly important point to keep in mind when discussing the yield curve. As a set of market-determined interest rates, the yield curve not only reflects market participants' views about the evolution of the economy but also their views about the FOMC's likely reaction to that evolution and uncertainty around these and other relevant factors. In other words, the yield curve represents not one signal, but several. The big question is, can we pull these signals apart to help appropriately inform the calibration of policy?
We can begin to make sense of this question by noting that Treasury yields of any given maturity can be thought of as the sum of two fundamental components:
- An expected policy rate path over that maturity: the market's best guess about the FOMC's rate path over time and in response to the evolution of the economy.
- A term premium: an adjustment (relative to the path of the policy rate) that reflects additional compensation investors receive for bearing risk related to holding longer-term bonds.
Among other things, this premium may be related to two factors: (1) uncertainty about how the economy will evolve over that maturity and how the FOMC might respond to events as they unfold and (2) the influence of supply and demand factors for U.S. Treasuries in a global market.
Let's apply this framework to the current yield curve. As several of my colleagues (including Fed governor Lael Brainard) have noted, the term premium is currently quite low. All else equal, this would result in lower long-term rates and a flatter yield curve. The term premium bears watching, but it is unclear that movements in the premium reflect particular concerns about the course of the economy.
I tend to focus on the other component: the expected path of policy. When we ask whether a flattening yield curve is a cause for concern, what we are really asking is: does the market expect an economic slowdown that will require the FOMC to reverse course and lower rates in the near future?
The eurodollar futures market shows us one measure of the market's expectation for the policy rate path. These derivative contracts are quoted in terms of a three-month rate that closely follows the FOMC's policy rate, which makes them well-suited for this kind of analysis. (Some technical details regarding this market can be found in a 2016 issue of the Atlanta Fed's "Notes from the Vault.")
Chart 2 illustrates the current estimate of the market's expected policy rate path. Read simply, the market appears to be forecasting continuing policy rate increases through 2020, and there is no evidence of a market forecast that the FOMC will need to reverse course in the medium term. However, the level of the policy rate is lower than the median of the FOMC's June Summary of Economic Projections (SEP) for 2019 and 2020.
Once we get past 2020, the market's expected policy path flattens. I read this as evidence that market participants overall expect a very gradual pace of tightening as the most likely outcome over the next two years. Interestingly, the market appears to expect a slower pace of tightening than the pace that at least some members of the FOMC currently view as "appropriate" as represented in their SEP submissions.
For this measure, I find the short-term perspective most informative. As one looks further into the future, the range of possible outcomes widens, as many the factors that influence the economy can evolve and interact widely. Thus, the precision of any signal the market is providing about policy expectations—if indeed there is any signal at all—is likely to be quite low.
With this information in mind, I do not interpret that the yield curve indicates that the market believes the evolution of the economy will cause the FOMC to lower rates in the foreseeable future. This interpretation is consistent with my own economic forecast, gleaned from macroeconomic data and a robust set of conversations with businesses both large and small. My modal outlook is for expansion to continue at an above-trend pace for the next several quarters, and I see the risks to that projection as balanced. Yes, there are downside risks, chief among them the effects of (and uncertainty about) trade policy. But those risks are countered by the potential for recent fiscal stimulus to have a much more transformative impact on the economy than I've marked into my baseline outlook.
I believe the yield curve gives us important and useful information about market participants' forecasts. But it is only one signal among many that we use for the complex task of forecasting growth in the U.S. economy. As the economy evolves, I will be assessing the response of the yield curve to incoming data and policy decisions along the lines I've laid out here, incorporating market signals along with a constellation of other information to achieve the FOMC's dual objectives of price stability and maximum employment.
June 1, 2018
Part-Time Workers Are Less Likely to Get a Pay Raise
A recent FEDS Notes article summarized some interesting findings from the Board of Governors' 2017 Survey of Household Economics and Decisionmaking. One set of responses that caught my eye explored the connection between part-time employment and pay raises. The report estimates that about 70 percent of people working part-time did not get a pay increase over the past year (their pay stayed the same or went down). In contrast, only about 40 percent of full-time workers had no increase in pay.
This pattern is broadly consistent with what we see in the Atlanta Fed's Wage Growth Tracker data. As the following chart indicates, the population of part-time workers (who were also employed a year earlier) is generally less likely to get an increase in the hourly rate of pay than their full-time counterparts. Median wage growth for part-time workers has been lower than for full-time workers since 1998.
This wage growth premium for full-time work is partly accounted for by the fact that the typical part-time and full-time worker are different along several dimensions. For example, a part-time worker is more likely to have a relatively low-skilled job, and wage growth tends to be lower for workers in low-skilled jobs.
As the chart shows, the wage growth gap widened considerably in the wake of the Great Recession. The share of workers who are in part-time jobs because of slack business conditions increased across industries and occupation skill levels, and median part-time wage growth ground to a halt.
While part-time wage growth has improved since then, the wage growth gap is still larger than it used to be. This larger gap appears to be attributable to a rise in the share of part-time employment in low-skilled jobs since the recession. In particular, relative to 2007, the share of part-time workers in the Wage Growth Tracker data in low-skilled jobs has increased by about 3 percentage points, whereas the share of full-time workers in low-skilled jobs has remained essentially unchanged. Note that what is happening here is that more part-time jobs are low skilled than before, and not the other way around. Low-skilled jobs are about as likely to be part-time now as they were before the recession.
How does this shift affect an assessment of the overall tightness of today's labor market? Looking at the chart, the answer is probably “not much.” As measured by the Wage Growth Tracker, median wage growth for both full-time and part-time workers has not been accelerating recently. If the labor market were very tight, then this is not what we would expect to see. The modest rise in average hourly earnings in the June 1 labor report for May 2018 to 2.7 percent year over year, even as the unemployment rate declined to an 18-year low, seems consistent with that view. A reading on the Wage Growth Tracker for May should be available in about a week.
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