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Friday, July 10, 2015 2:04 PM

Reflections on "Uncertainty"; Yellen Expects Rates Hikes but "Uncertain" about Growth, Jobs, Inflation, Wages

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The word of the day is "uncertain". It appears a number of times (in various forms) in Fed Chair Janet Yellen's speech on Recent Developments and the Outlook for the Economy at the City Club of Cleveland, Cleveland, Ohio.

Here are some Yellen Yap snips, emphasis in italics and some subtitles mine.

Employment Slack

It is my judgment that the lower level of the unemployment rate today probably does not fully capture the extent of slack remaining in the labor market--in other words, how far away we are from a full-employment economy.

Part-Time Jobs

Another factor we consider when assessing labor market slack is the elevated number of workers who are employed in part-time jobs but would prefer to have full-time work--in other words, those classified as "part time for economic reasons." At around 4-1/2 percent of employment, the share of such workers is notably larger than has been historically typical in a growing economy.

Some portion of the greater share of workers who are part time for economic reasons may reflect structural rather than cyclical factors. For example, the ongoing shift in employment away from manufacturing and toward services, a sector which historically relied more heavily on part-time workers, may be boosting the share of part-time jobs. Despite these structural trends, which make it difficult to know where the share of those employed part time for economic reasons may settle in the longer run, I continue to think that it probably remains higher than it would be in a full-employment economy.

Other indicators also generally corroborate the view that while the labor market has improved, it still has not fully recovered. For example, the rate at which employees quit their jobs for other opportunities has tended to go up in a strong economy, since more workers voluntarily leave their jobs when they have greater confidence about their ability to find new ones and when firms are competing more actively for new hires. Indeed, the quits rate has picked up as the labor market has improved over the past few years, but it still is not as high as it was through much of the early 2000s.


The pace of wage increases also may help shed some light on the degree of labor market slack, since wage movements historically have tended to respond to the degree of tightness in the labor market. Here too, however, the signal is not entirely clear, as other factors such as longer-run trends in productivity growth also generally influence the growth of compensation. Key measures of hourly labor compensation rose at an annual rate of only around 2 percent through most of the recovery. More recently, however, some tentative hints of a pickup in the pace of wage gains may indicate that the objective of full employment is coming closer into view.


The stronger dollar has pushed down the prices of imported goods, and that, in turn, has put downward pressure on core inflation. In addition, the plunge in oil prices may have had some indirect effects in holding down the prices of non-energy items in core inflation, as producers passed on to their customers some of the cost savings from lower energy prices. In all, however, these downward pressures seem to be abating, and the effects of these transitory factors are expected to fall out of measures of inflation by early next year.

Very low inflation may not sound like a real problem to many people. However, persistently low price inflation, which can tend to slow the pace of wage increases over time, can weaken the economy by, for example, making it more difficult for households and firms to pay off their debts. A persistent, very low inflation environment also tends to result in chronically low short-term interest rates. This type of situation would leave less scope for the FOMC to respond with its conventional monetary policy tool--namely, a cut in the federal funds rate--to counteract a weakening in the economy.

Outlook for the Economy

The latest estimates show that both real GDP and industrial production actually edged down in the first quarter of this year. Some of this weakness appears to be the result of factors that I expect will be only transitory, such as the unusually harsh winter weather in some regions of the country and the West Coast port labor dispute that briefly restrained international trade and caused disruptions in manufacturing supply chains. Also, statistical noise or measurement issues may have played some role.

Nevertheless, at least a couple of other more persistent factors also likely weighed on economic output and industrial production in the first quarter. In particular, the higher foreign exchange value of the dollar that I mentioned, as well as weak growth in some foreign economies, has restrained the demand for U.S. exports. Moreover, lower crude oil prices have significantly depressed business investment in the domestic energy sector. Indeed, industrial production continued to decline somewhat in April and May. We expect the drag on domestic economic activity from these factors to ease over the course of this year, as the value of the dollar and crude oil prices stabilize, and I anticipate moderate economic growth, on balance, for this year as a whole.

As always, however, the economic outlook is uncertain. Notably, although the economic recovery in the euro area appears to have gained a firmer footing, the situation in Greece remains unresolved.

Looking further ahead, I think that many of the fundamental factors underlying U.S. economic activity are solid and should lead to some pickup in the pace of economic growth in the coming years. In particular, I anticipate that employment will continue to expand and the unemployment rate will decline further.

There are a couple of factors, however, that I expect could restrain economic growth. First, business owners and managers remain cautious and have not substantially increased their capital expenditures despite the solid fundamentals and brighter prospects for consumer spending. Businesses are holding large amounts of cash on their balance sheets, which may suggest that greater risk aversion is playing a role. Indeed, some economic analysis suggests that uncertainty about the strength of the recovery and about government economic policies could be contributing to the restraint in business investment.


While national home prices have been rising for a few years and home sales have improved recently, residential construction has remained quite soft. Many households still find it difficult to obtain mortgage credit, but, more generally, the weak job market and slow wage gains in recent years appear to have induced people to double-up on housing. For example, many young adults continue to live with their parents. Population growth is creating a need for more housing, whether to rent or to own, and I do expect that continuing job and wage gains will encourage more people to form new households. Nevertheless, activity in the housing sector seems likely to improve only gradually.

Implications for Monetary Policy

Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy. But I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step.

Let me also stress that this initial increase in the federal funds rate, whenever it occurs, will by itself have only a very small effect on the overall level of monetary accommodation provided by the Federal Reserve. Because there are some factors, which I mentioned earlier, that continue to restrain the economic expansion, I currently anticipate that the appropriate pace of normalization will be gradual, and that monetary policy will need to be highly supportive of economic activity for quite some time.

The projections of most of my FOMC colleagues indicate that they have similar expectations for the likely path of the federal funds rate. But, again, both the course of the economy and inflation are uncertain. If progress toward our employment and inflation goals is more rapid than expected, it may be appropriate to remove monetary policy accommodation more quickly. However, if progress toward our goals is slower than anticipated, then the Committee may move more slowly in normalizing policy.

Long-Run Economic Growth

The most important factor determining continued advances in living standards is productivity growth, defined as the rate of increase in how much a worker can produce in an hour of work. Over time, sustained increases in productivity are necessary to support rising household incomes.

Here the recent data have been disappointing. The growth rate of output per hour worked in the business sector has averaged about 1‑1/4 percent per year since the recession began in late 2007 and has been essentially flat over the past year. In contrast, annual productivity gains averaged 2-3/4 percent over the decade preceding the Great Recession. I mentioned earlier the sluggish pace of wage gains in recent years, and while I do think that this is evidence of some persisting labor market slack, it also may reflect, at least in part, fairly weak productivity growth.

There are many unanswered questions about what has slowed productivity growth in recent years and about the prospects for productivity growth in the longer run. But we do know that productivity ultimately depends on many factors, including our workforce's knowledge and skills along with the quantity and quality of the capital equipment, technology, and infrastructure that they have to work with.
No Lights

Yellen really did not shed any light on anything. Of course, the Fed can never shed any light on anything.

As pertains to monetary policy, I can sum up her speech in one line: "We don't know, and nobody else does either."

As pertains to inflation, we do know she remains totally clueless. The idea we need inflation so the Fed can react with interest rates cuts to stimulate the economy is patently absurd.

Unfortunately, people hear that from the Fed and clueless Keynesian economists so many times they come to believe it even as they hold two contradictory ideas in their head at the same time.

  1. Consumers believe lower prices are good so their dollar goes further
  2. They believe nonsense from the Fed that inflation is good

Yellen says low inflation makes it "difficult for households and firms to pay off their debts".

She never once entertained the notion that Fed monetary policy induces people and businesses to take on too much debt in the first place.

Economy is Not a Truck

The economy cannot be steered like a truck on a winding road. The idea that a group of central planners can sit in a room and decide the appropriate interest rates, the appropriate employment, the appropriate money supply, and the appropriate level of growth is more absurd than the idea that Soviet central planners could determine the precise amount of steel to produce.

It is far more difficult to set appropriate money supply and interest rates than it would be to centrally plan the price of orange juice.

Yet, people expect the Fed to accurately set monetary policy, even though their eyebrows would leave their face if the Fed decided to dictate the price of orange juice.

Central Bank Results

The results speak for themselves: The Fed has blown stock market bubble after bubble, each with increasing amplitude.

  • China is in a panic stock market decline and a massive housing bubble as a culmination of its manipulative efforts.
  • Japan is in the midst of a central-bank crisis of its own, with a debt-to-GDP ratio of about 250%, the highest in the developed world.
  • In the US, the equity and junk bond markets are in a massive bubble the Fed does not even see. Of course, the Fed did not see the dot-com crash, the housing bubble, or the great recession either.
  • In Europe, the ECB's "one size fits Germany" interest rate policy has created a massive mess.
  • Globally, central bank manipulations are at the very heart of the rising income inequality that Yellen occasionally rants about. 

Reflections on "Uncertainty"

The Fed never sees the problems it fosters until the bubbles burst.

The only thing "uncertain" is when the various bubbles blow up. That's what Yellen is really saying; she just doesn't realize it.

Mike "Mish" Shedlock

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