Economic Outlook and Monetary Policy

Transcription

1 Economic Outlook and Monetary Policy Northwestern University Advanced Workshop for Central Bankers September 9, 218 Spencer Krane Senior Vice President Federal Reserve Bank of Chicago The views I express here are my own and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or within the Federal Reserve System. 1

2 Topics for Today Growth Sector developments; potential output; forecast Inflation Recent developments; Phillips curve issues Financial conditions The yield curve and recessions Monetary policy Unconventional policies at the ELB; outlook for policy; estimates of r* 2 2

3 Economy Close to Potential by Most Estimates Real and Potential GDP (log bil. 29 $, saar) 1. SEP Forecast 9.8 Q Potential Actual 3 2 Q4/Q4 percentage change ' '5 '1 '15 '2 Source: BEA (actual), CBO (potential, with FRBC adj for NIPA revisions), FOMC's Summary of Economic Projection from Haver Analytics 3

4 Labor Markets Unemployment Rate (percent) Labor Force Participation Rate (percent) Predicted Using Unemployment Gap 9 66 Trend 6 Aug-218 FOMC Projections 3 21 '5 '9 '13 '17 64 FOMC Long-run Central Tendency '5 '9 '13 '17 Aug-218 Source: BLS and FOMC s Summary of Economic Projections from Haver Analytics Trend and predictions from gap taken from Chicago Fed staff estimates 4

5 Wages Wage Growth (year over year percentage change) 5 4 Average Hourly Earnings 3 Q2-218 Aug Employment Cost Index 1 26 '8 '1 '12 '14 '16 '18 Source: BLS from Haver Analytics 5

6 Household Sector Real Personal Consumption exp. (Q4/Q4 percentage change) Housing Starts (millions of units, annual rate) Single-family Multi-family 1. Jul '6 '8 '1 '12 '14 '16 '18 H1. 24 '6 '8 '1 '12 '14 '16 '18 Source: BEA and Census Bureau from Haver Analytics 6

7 Business Sector Business Fixed Investment (Q4/Q4 percentage change) Capital Deepening (percent change in input of capital services to trend hours) Average '6 '8 '1 '12 '14 '16 '18 H '85 '9 '95 ' '5 '1 '15 Estimated revision for capital services calculated from internal Chicago Fed staff estimates Source: BEA, BLS, and CBO from Haver Analytics 7

8 Business Sector Business Fixed Investment (Q4/Q4 percentage change) Capital Deepening (percent change in input of capital services to trend hours) Average Estimated revision '6 '8 '1 '12 '14 '16 '18 H '85 '9 '95 ' '5 '1 '15 Estimated revision for capital services calculated from internal Chicago Fed staff estimates Source: BEA, BLS, and CBO from Haver Analytics 8

9 International Trade Current Account Balance (as a percentage of GDP, NIPA basis) 2 % Contribution of Net Exports to GDP Growth 17 Q3 Q4 18 Q1 Q Q ' '5 '1 '15 Source: BEA from Haver Analytics 9

10 Government Federal Government Deficit (w/ Cyclical Adjustment) (as a percentage of GDP) CBO Estimates of the Effects of Recent Fiscal Actions Tax Act Bipartisan Budg & Approp. Act.3.6 n.a. n.a CBO Projections '85 '9 '95 ' '5 '1 '15 '2 '25 Source: CBO Budget and Economic Outlook: 218 to 228, April 218 1

11 Potential GDP Growth Appears to Have Slowed CBO Real Potential GDP (Q4/Q4 percentage change) Source: Congressional Budget Office from Haver Analytics 11

12 Potential GDP Growth Appears to Have Slowed Slower population growth and declining labor force participation imply slower growth in available workers Slower growth in capital investment and disappointing total factor productivity growth imply slower labor productivity growth Trend Growth In Available Workers Labor Productivity TFP GDP Source: CBO 1. TFP is for nonfarm business sector 12

13 FOMC Growth and Unemployment Forecasts Median forecast, June 218 Summary of Economic Projections Variable LR GDP Unemployment Memo: August Blue Chip 3 GDP Unemployment Q4-to-Q4 percent change 2. Q4 Average 3. August 1, 218 Blue Chip consensus 4. From March 1, 218 Blue Chip consensus 13

14 Inflation Appears Finally Back to Target PCE Price Index (12-month percent change) Total Core FOMC Long-run Target Jul '6 '8 '1 '12 '14 '16 '18 '2 Source: BEA and FOMC s Summary of Economic Projections from Haver Analytics 14

15 Dollar and Oil Prices Short Term Inflation Factors (index, 26=1) Brent Crude Oil Prices and Futures ($/barrel) Non-Petroleum Import Prices 125 Jul Futures 6-Sep-218 Broad Trade-Weighted Dollar 8 26 '8 '1 '12 '14 '16 ' '8 '1 '12 '14 '16 '18 '2 Source: BLS, Federal Reserve Board, and ICE from Haver Analytics 15

16 Inflation Expectations Inflation Surveys (percent) Market Pricing (percent) 4 University of Michigan Expected CPI Inflation: 5-1 years ahead 4 TIPS 5F/5 Inflation Compensation 3 3 Aug Sep-18 2 SPF CPI 1-yr Forecast SPF PCE 1-yr Forecast 2 3 Year Ahead Expected Inflation from DSTM model 218 Q '8 '1 '12 '14 '16 ' '8 '1 '12 '14 '16 '18 3 Year Ahead Inflation Expectations calculated from internal Chicago Fed staff estimates Source: University of Michigan, Federal Reserve Board, and Federal Reserve Bank of Philadelphia (Survey of Professional Forecasters--SPF) 16

17 Decomposition of Inflation Deviation of Inflation from 2 Percent (percent).5 π t = π c t + ω e trpie t + ω f trpif t π c t =.4*π e t +.36*π c t *π c t-2.8*slack t +.56*RPIM t + ε t (est.) Relative Food/Energy Prices Relative Import Prices Slack Other Total Shortfall Source: Federal Reserve Board of Governors, Inflation, Uncertainty, and Monetary Policy, speech by Janet Yellen, September 26,

18 Inflation Outlook: Slight Overshooting PCE Price Index (12-month percent change) Total Core June 218 SEP Forecasts Total Core FOMC Long-run Target FOMC Projections* Jul '6 '8 '1 '12 '14 '16 '18 '2 Source: BEA and FOMC s Summary of Economic Projections from Haver Analytics 18

19 Evolution of the Phillips Curve Coefficients of π c t = a(u t - u* t ) + b π c t-1 (2-year rolling regression) a + ε t b Source: Christopher Erceg, James Hebden, Michael Kiley, Daved Lopez-Salido, and Robert Tetlow (218). Some Implications of Uncertainty and Misperception for Monetary Policy, Finance and Economic Discussion Series Board of Governors of the Federal Reserve System. 19

20 Implications of Small a, b < 1 π c t = a (u t - u* t ) + (1-b) E p [π c t ] + b π c t-1 + c X t + ε t Small a: Inflation unlikely to pick up substantially as u < u* b < 1: Non-accelerationist Phillips curve; if inflation expectations anchored, inflation will settle at E p [π c t] Caveats: Nonlinear Phillips curve? What does it take to unhinge E p [π c t] in either direction? 2 2

21 Financial Conditions Chicago Fed's National Financial Conditions Index (relative to average) Adjusted Aug '88 '92 '96 ' '4 '8 '12 '16 Source: Federal Reserve Bank of Chicago 21

22 Flattening Yield Curve Treasury Rates (percent) Aug Year 1 2-Year Source: Board of Governors of the Federal Reserve System from Haver Analytics 22

23 Yield Curve Slope Yield Curve (percent) 3 Current Aug-215 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 1Y Maturities Source: Board of Governors of the Federal Reserve System from Haver Analytics 23

24 Yield Curve Slope and Recessions Treasury 1 year rate minus 2 year rate (percentage points) Aug '7 '75 '8 '85 '9 '95 ' '5 '1 '15 Source: Board of Governors of the Federal Reserve System from Haver Analytics 24

25 Yield Curve Slope and Recessions Probability of recession in the next year (percent) Q Source: Eric Engstrom and Steven Sharpe, "(Don't Fear) the Yield Curve", FEDS Notes, Board of Governors of the Federal Reserve System 25

26 Yield Curve Slope: Expectations and Risk r 1 t 1 E 1 t r 1 1 t + r t r t r t+1 + tp t 1 r t 1 1-year interest rate; r t 1 1-year interest rate tp t 1 term premium; real rate risk plus inflation risk Yield curve slope: r 1 t r 1 t. It will flatten when: Relatively Looser monetary policy tomorrow vs. today Tighter monetary policy today vs. tomorrow Risk premia fall 26 26

27 Probit Estimates: Prob. Enter Recession in a Year Engstrom- Sharpe 1 Short spread -.35 (<.1) Benzoni, Chyruk, Kelley (<.1) Long spread -.6 (.43) Long real risk spread.2 (<.1) Long inflation risk spread -.12 (<.1) Current short real rate -.24 (.4) P-values in parentheses. 1. Short spread = 6-qtr fwd current 3-m T-bill; long spread = current 1 yr 2 yr Treas. 2. Short spread = 6-qtr ahead DSTM exp real rate current real ratel; long spreads are risk difference between 1-yr and 2-yr ahead DSTM risk premia 27

28 Yield Curve Slope and Recessions Engstrom and Sharpe Recession Probabilities (percent) Near-Term Spread Long-Term Spread Q Source: Eric Engstrom and Steven Sharpe, "(Don't Fear) the Yield Curve", FEDS Notes, Board of Governors of the Federal Reserve System 28

29 Yield Curve Slope and Recessions Benzoni et al Recession Probabilities (percent) Short-spread plus Yields Decomposition Long-Term Spread Q Source: internal Chicago Fed staff calculations 29

30 Yield Curve Slope in August FOMC Minutes Several participants cited statistical evidence for the United States that inversions of the yield curve have often preceded recessions. They suggested that policymakers should pay close attention to the slope the yield curve in assessing the economic and policy outlook. 3 3

31 Yield Curve Slope in August FOMC Minutes Other[s] emphasized inferring economic causality from statistical correlations was not appropriate. A number of global factors were seen as contributing central bank asset purchase programs and the strong worldwide demand for safe assets. In such an environment, an inversion of the yield curve might not have the significance that the historical record would suggest; the signal needed to be considered in the context of other economic and financial indicators

32 Monetary Policy Federal Funds Target Rate (percent) Q Source: July 218 Monetary Policy Report, Board of Governors of the Federal Reserve System 32

33 Benchmarking Monetary Policy Federal Funds Target Rate (percent) 9 Balanced Approach Rule r(t) = r LR (t) + π(t) +.5( π(t) π LR ) + 2( u LR (t) u(t) ) Q r LR (t) and u LR (t) from Blue Chip Consensus Forecast. Source: July 218 Monetary Policy Report, Board of Governors of the Federal Reserve System 33

34 Nonconventional Policy Tools at the ELB r 1 t 1 E 1 t r 1 1 t + r t r t r t+1 + tp t 1 1 Lowering long rates when can t change near-term r t+j Option 1: Communications -- Lower expectations of 1 average future r t+j rates with forward guidance on future policy Option 2: Buy long-term bonds to Reduce tp t 1 Reinforce option

35 Funds Rate and Nonconventional Policy Federal Funds Target Rate (percent) 6 5 For some time LSAP I LSAP Ia; Extended period LSAP II Mid-213 Late-214 MEP LSAP III; Mid-215 LSAP IIIa; Outcome-based FG Source: Board of Governors of the Federal Reserve System from Haver Analytics 35

36 Forward Guidance Economic conditions likely to warrant exceptionally low level of the funds rate: Dec. 28 for some time ; Mar. 29 extended period Aug. 211 at least through mid 213 ; Jan. 212 at least through late 214 and fed funds dot plot added Sep. 212 for a considerable time after the economic recovery strengthens.at least through mid-215 Dec. 212 as long as unemployment rate > 6-1/2 percent; projected inflation < 2-1/2 percent; longer-term inflation expectations well-anchored

37 Forward Guidance Dec. 213: likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation below 2 percent longer-run goal December 215 May 218 The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run

38 Asset Purchases November 28: $1 bil. agency; $5 bil. MBS March 29: $3 bil. Treasury; $1 bil. agency; $75 bil. MBS November 21: $6 bil. Treasury September 211: MEP/Operation Twist September 212: Open ended purchases of $4 bil. MBS per month; MEP extension December 212: Open ended purchases of $45 bil. Treasury per month. (began tapering Dec 213 completed Oct 214) October 217: Start winding down balance sheet

39 Monetary Policy Target Federal Funds Rate at Year-End (percent) Long-run Red dots indicate median. Source: FOMC June 218 Summary of Economic Projections 39

40 Gradual Balance Sheet Normalization Projected SOMA Domestic Securities Holdings: Alternative Liabilities Scenarios (billions $) 4,5 4, Larger Liabilities 3,5 3, 2,5 2, Median Smaller Liabilities 1,5 1, 5 24 '6 '8 '1 '12 '14 '16 '18 '2 '22 '24 Source: Federal Reserve Bank of New York 217 Open Market Annual Report, published in April 218 4

41 Benchmarking Monetary Policy Target Federal Funds Rate at Year-End and Inertial Taylor Rule (percent) Inertial Taylor Long-run Source: FOMC June 218 Summary of Economic Projections 41

42 Estimates of the Real Natural Rate of Interest Range of Estimates from econometric models, Blue Chip and SEP long-run r (percent) Blue Chip r* SEP Longer-Run Real Federal Funds Rate Q '2 '4 '6 '8 '1 '12 '14 '16 '18 Source: July 218 Monetary Policy Report, Board of Governors of the Federal Reserve System 42

43 Estimates of the Real Natural Rate of Interest Time Series New Keynesian IS: y a ( L) y a ( L)( r r ) y E [ y ] a ( r r ) c c * yc c c * yc t y t 1 r t 1 t 1 t t t t 1 r t t t PC: b y b ( L) b y E [ ] c c t y t 1 t 1 t t y t t t 1 t r : r cg z r r d d y * * * c r t t t t t t yc t t z z d ( L) z d X ; d (1) 1 t z t 1 x t t z c c Setting r r* y in long run Setting r r* y today t t 43 43

44 Estimates of the Real Natural Rate of Interest Laubach-Williams r* (percent) Chicago Fed DSGE r* (percent) LW I(1) z t 5-Year ahead r* -5-5 Current LW I() z t Source: Federal Reserve Bank of San Francisco and internal Chicago Fed staff calculations 44

45 Implications of r* estimates Great deal of uncertainty over r* => Look to many indicators for judging the stance for policy Low r* => Less room to the ELB Say nominal r* 2-3/4 to 3 percent; even in less severe 199 and 21 recessions, Fed cut 5 percentage points Consider alternative frameworks? Target nominal income, price level, conditional price level, etc. Recognize may have to use nonconventional tools again in the future 45 45

46 Appendix 46 46

47 Investment Private Nonresidential Fixed Investment (contribution to percentage change in GDP) Total Structures (23%) Equipment (45%) Intellectual Property (32%) Q H1 47

48 Monetary Policy Target Federal Funds Rate at Year-End (percent) Survey of Primary Dealers Market Pricing Long-run Market expectations as derived from OIS futures as of September 6, 218 and the July/August Survey of Primary Dealers. Red dots indicate median. Source: FOMC Summary of Economic Projections 48

49 Benchmarking Monetary Policy Target Federal Funds Rate at Year-End and Inertial Taylor Rule (percent) 6 5 Taylor 99 (Balanced Approach) 4 Inertial Taylor Long-run Source: FOMC June 218 Summary of Economic Projections 49

50 Treasury Rates 1 Year Treasury (percent) 3 5-Sep '16 '17 '18 Source: Board of Governors of the Federal Reserve System from Haver Analytics 5

51 Estimates of the Real Natural Rate of Interest Source: July 218 Monetary Policy Report, Board of Governors of the Federal Reserve System 51