Speech by Governor Brainard on the economic outlook and implications for monetary policy
Governor Lael Brainard - At the Council on Foreign Relations, Washington, D.C. - June 3, 2016
The Economic Outlook and Implications for Monetary Policy
In recent months, financial conditions have eased, and there are encouraging signs that consumption has regained momentum. On the other hand, there are tentative signs of slowing in the labor market and risks remain.1 We cannot take the resilience of our recovery for granted.
Recent Developments
As we consider the appropriate posture of policy going forward, the most immediate question is whether the data provide confidence that domestic economic activity has strengthened notably following two disappointing quarters. This is critical for making progress on the Committee's dual mandate objectives of full employment and 2 percent inflation. The data in today's labor market report on balance suggest that the labor market has slowed. Nonfarm payroll employment increased at an average monthly pace of 116,000 over the last three months--well below the 220,000 per month average pace over the preceding twelve months. The unemployment rate moved lower, reaching 4.7 percent, a new low in the current recovery, but involuntary part-time employment increased and the labor force participation rate declined.
Even so, there are reasons to expect that the labor supply still has room to respond if labor demand increases. Importantly, the employment to population ratio for prime-age workers still remains 1-3/4 percentage points below pre-crisis levels. The recent data on wage inflation suggest a similar conclusion. Although there have been some signs of increasing wage growth recently, the step-up has been modest, and growth in the broad measures of wages remains quite low. For example, the average change over the past year across the three most commonly cited wage measures was about 2-1/2 percent, compared with an average change from the end of 2009 to the end of 2014 of 2 percent.2
The recent news on inflation--the second leg of our dual mandate--has also been mixed. The price of oil has rebounded significantly from the lows reached earlier in the year on expectations that supply and demand are likely to come into better alignment. Over the same period, the dollar has receded a bit, on net, from its peak in January, though it is still about 15 percent above the level in mid-2014 in inflation-adjusted trade-weighted terms. As a result, non-oil import prices look likely to stabilize this quarter after a year and a half of declines. Still, it should be noted that these developments coincided with the easing in financial conditions since mid-February and are likely due, at least in part, to expectations of more gradual U.S. monetary policy tightening. If those expectations were to shift materially, the conditions supporting higher inflation could diminish.
While there are thus signs that inflation will move higher over the medium term, measures of core inflation have yet to convincingly exceed the low levels that have prevailed over much of the recovery. The 12-month change in core personal consumption expenditure (PCE) prices, a reasonable proxy for the underlying trend in inflation, was only 1.6 percent in April. This is still noticeably below our target and is roughly equal to the average change in core and total PCE inflation from the end of 2009 to the end of 2014.
We cannot rule out that stubbornly low inflation may be having an effect on inflation expectations. Market-based measures of inflation compensation--which reflect inflation risk and liquidity premiums, as well as inflation expectations--remain extremely low. For example, inflation compensation at the five-year, five-year-ahead horizon is currently around 1.5 percent, 1-1/4 percentage points below levels prevailing prior to mid-2014. Some survey-based measures of inflation expectations are also somewhat below historical norms. Median 5- to 10-year inflation expectations in the University of Michigan Surveys of Consumers, for example, over the past year have been on average about 1/4 percentage point below the average over the 10 years from 2005 to 2014.
Thus, although some signs point to a firming of inflation going forward, I view the persistently low level of inflation during the recovery together with some signs of a deterioration in inflation expectations as suggesting that the risks to the return of inflation to our 2 percent target over the medium term are weighted to the downside.
Progress toward our goals of full employment and 2 percent inflation will depend importantly on solid growth in aggregate demand. Following disappointing gross domestic product (GDP) growth in the fourth quarter of last year and the first quarter of this year that averaged only 1.1 percent, I have been very attentive to incoming data, especially on consumption, which point to a pick-up in growth this quarter.3 In particular, consumer expenditures rose a strong 0.6 percent in April, and auto sales edged higher in May. These are encouraging signs, but the data relevant for second-quarter growth are still relatively sparse.
In general, demand growth in recent quarters has benefited from a relatively strong household sector--buoyed by a recovering labor market, reduced oil prices, and low interest rates--and has been pulled down by weak business investment and net exports. Indeed, consumption and housing investment can more than account for the 2 percent increase in GDP over the past four quarters. By contrast, business investment and net exports together subtracted 1/4 percentage point. The rise in the dollar and decline in foreign growth reduced demand for American exports, as well as profits and investment at U.S. firms, which were also adversely affected by declines in the price of oil. Over the twelve months ending in April, manufacturing output increased only 0.4 percent, while total industrial production, which also includes the drilling for, and extraction of, oil and gas, fell 1.1 percent. Although the most recent indicators suggest that weakness in investment and net exports has persisted into the current quarter, if the easing in financial conditions since mid-February and the recent firmness in oil prices were to continue, along with stabilization of the dollar, business investment and exporters would benefit.
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