Regional President Speech

Home / News / Speeches / Thomas I Barkin / 2022 Money Marketeers of New York University • When the Fed determines how to contain in�ation, the conditions matter. • Before the pandemic, we had a period with "the wind at our back" when it came to containing in�ation. A number of disin�ationary factors a�ected the real economy and the Fed's success depended on us recognizing them, understanding their impact and adjusting. • The pandemic has been quite a storm; bringing, it seems, one short-term in�ationary gust after another. Initially, we thought in�ation would be short-lived. Now, with in�ation persisting and broadening, we have moved to start to normalize our monetary policy stance. • What direction the winds will be blowing going forward remains an open question. There are reasons to think we may face more headwinds, requiring us to navigate in the context of more medium-term in�ationary pressure. If that's the case, we may need to note the conditions and adjust. This speech was delivered remotely. Thanks for having me today. It’s great to be back in front of this group. Today, I want to take a step back and look beyond today’s headlines. I caution these views are mine alone and not necessarily those of any of my colleagues on the Federal Open Market Committee (FOMC) or in the Federal Reserve System. The direction of the wind matters. Jim Croce once famously said you don’t spit into the wind. The Irish blessing asks that the wind always be at your back. But maybe Virginia country singer and sausage entrepreneur Jimmy Dean said it best: We can’t change the direction of the wind, but we can adjust our sails. If you’re a sailor like my daughter or even a golfer like me, that notion is pretty familiar. You adjust your game based on the conditions you face. I think this analogy extends to the question of how the Fed contains in�ation. The conditions matter. We take note, and we adjust our course. To give my Fed predecessors due credit, a lot of work has gone into anchoring in�ation expectations over the last generation. As a result, our economy has seen healthy growth and an era of remarkably low and stable in�ation. During this period, a number of disin�ationary factors a�ected the real economy. This “series of fortunate events” (if I can borrow from the children’s books) could be described as putting “the wind at our back” when it came to containing in�ation. But our success depended on us recognizing those factors and adjusting. The best known such story is probably in the late ‘90s, when the Fed deferred interest rate increases, recognizing that technology-enabled productivity would limit in�ationary pressure in that period. But there are several other examples of disin�ationary forces: Globalization, especially the rise of India and China, gave producers access to ever-greater proportions of lower-cost labor and consumers ever-increasing access to lower-cost products. Technology enabled innovation. No one could have predicted the explosive growth of e- commerce, which lowered the barrier to price comparisons and cut costs for retailers. Or how fracking provided additional supplies of natural gas and then oil once thought to be depleting. The “e�ective” labor force grew strongly, both in numbers (the baby-boom generation, high levels of immigration and o�shore labor pools as mentioned earlier) and in participation (women in the workplace, higher educational attainment improving employability and better health enabling longer careers). Professional purchasing organizations emerged and grew in retailers (e.g., Walmart) and manufacturers (e.g., automobiles), exerting continual year-over-year pressure on costs, and consequently prices. And the federal government in the era between the early ‘90s and the Great Recession ran relatively low de�cits, meaning lower in�ationary �scal impulses. These forces particularly in�uenced pricing for goods. Goods in�ation for the 20 years ending in 2019 were low at 0.4 percent per year, while services grew at 2.6 percent a year, leaving core in�ation near target at 1.7 percent. We recognized those disin�ationary tailwinds and — as we learned their impact — adjusted policy. In the context of anchored in�ation expectations, perhaps that is why we kept in�ation near target for so long while running what was then conventionally viewed as accommodative policy. With wind at our back, a lighter touch on the rudder was all it took. It’s hard to remember today, but just 15 months ago, 12-month core PCE was only 1.5 percent. But it’s quite clear, the wind conditions have shifted, at least for now. The pandemic has been quite a storm; bringing, it seems, one short-term in�ationary shock after another. We saw the pandemic shift demand to goods as it simultaneously suppressed supply of labor both here and abroad. We saw sizable �scal stimulus escalate demand more broadly, while excess savings perhaps reduced labor supply. We saw new variants slow our labor market recovery further. We saw a long series of atypical events — a severe winter storm in Texas, a �re at a chip plant in Japan, a ship lodged in the Suez Canal, a backlog in Long Beach — sti�e the supply chain. And, of course, most recently we’ve seen commodity price shocks coming out of the con�ict in Ukraine and new lockdowns in China. Where have these winds taken us? Demand is strong and looks to remain robust, fueled by healthy business and personal balance sheets, the need to replenish low inventories and state governments that are �ush with cash. We may see more variants, such as the one rising in Western Europe, but we are learning to live with COVID-19. Supply is tight. As demand for goods exploded in the midst of the pandemic, supply chains have struggled to keep up, and now to catch up. Labor markets are also quite tight. Unemployment has dropped to 3.6 percent. In addition, the pool of available labor has shrunk: 1.6 million fewer workers are in the workforce, and immigration remains well below its pre-COVID-19 trend. As a result, wages are up: Average hourly earnings have risen 5.6 percent. And price in�ation is elevated, with core PCE at 5.4 percent — the highest since April 1983. Over the past year, goods in�ation has been almost 10 percent, while services in�ation has been 4.6 percent. These shocks have required us, once again, to recognize changes and adjust our course. Initially, we thought in�ation would be short-lived, as it seemed largely driven by temporary factors like chips in cars. But the fog of the pandemic made visibility di�cult. Now, with in�ation persisting and broadening, we see clearly that it is time to normalize our monetary policy stance. At our last meeting, the Fed decided to raise interest rates 25 basis points, and the median Federal Open Market Committee member forecasted seven rate increases this year and three to four next year. These forecasts project in�ation to be contained as pandemic pressures ease and rates move just past the median estimate of neutral. How far we will need to raise rates in fact won’t be clear until we get closer to our destination, but rest assured we will do what we must to address this recent bout of above- target in�ation. And this commitment does not necessarily require a hard landing. In fact, it might help avoid one by convincing individuals and �rms that the Fed is committed to our target, thereby cementing in�ation expectations. An interesting question for me is: Once these speci�c pandemic-era wind gusts fade, what direction will the winds be blowing going forward? There are a few reasons to think we may face more headwinds when it comes to containing in�ation going forward. That is, we may need to navigate in the context of more medium- term in�ationary pressure than we have experienced during the Great Moderation. Over the last few years, we’ve seen tari�s, the pandemic, and the Ukrainian con�ict lay bare the vulnerabilities associated with o�shoring and a globally complex supply chain. Moving forward, we are likely to see some deglobalization, as countries rethink their trading relationships and �rms redesign their supply chains to prioritize resiliency, not just e�ciency. These changes would suggest higher costs and less ability for intermediaries to drive year-over-year e�ciencies. We may also see labor transition from being long to short. O�shore labor may prove less available. At the same time, our population is aging. Birth rates are declining. We missed out on millions of immigrants during the pandemic. Reduced labor force growth can limit growth in the broader economy. And unless we can �nd a way to reduce labor demand (e.g., through automation) or increase participation (as Japan has done with older workers), a tighter labor market could also pressure wages, and in turn, prices. Fiscal policy may also be shifting in a way that contributes to the headwinds. Government de�cits are still running at historic levels, and entitlement spending will grow further as the population ages. Defense spending may grow as well. The coming investment in climate transition risks elevating energy costs in the interim. Finally, the Great Moderation was marked by a relatively stable external environment. Who knows what the future holds. If we �nd ourselves facing this “series of unfortunate events,” we will recognize headwinds that become persistent and adjust how we navigate. Our goal — 2 percent target in�ation — wouldn’t change, nor would our longer-run ability to meet that goal, but the appropriate path to achieve it could. Should the prevailing winds shift, we would be more likely to face periods with real forces imparting near-term in�ationary pressure. These pressures could make “looking through” short-term shocks more di�cult. As a consequence, our e�orts to stabilize in�ation expectations could require periods where we tighten monetary policy more than has been our recent pattern. You might think of this as leaning against the wind. Doing so would be consistent with our �exible average in�ation targeting framework. Communicating e�ectively could also prove more challenging. In�ationary pressure puts constantly on the table the potential for a trade-o� between employment and in�ation, our dual mandate goals. In contrast, the last 10 years have seen little con�ict between our goals in making policy, and so the Fed’s decisions have been relatively easier to explain. We will need to be crystal clear that a growing economy requires stable prices, and that we will remain committed to addressing in�ationary gusts. We don’t need to make any of these judgments now. It is notoriously di�cult to pinpoint shifts in the weather, and the old joke is that economic forecasting was invented to make weather forecasters look good. Innovations happen, and it’s of course possible that technology will again create tailwinds we haven’t anticipated. Without perfect foresight, the best short-term path for us is to move rapidly to the neutral range and then test whether pandemic-era in�ation pressures are easing, and how persistent in�ation has become. If necessary, we can move further. Longer term, I am paying attention to the global forces I’ve described — whether they occur, in fact, and what impact they have on in�ationary pressures. If we see headwinds persisting, we will do what we need to do to trim the sails. This re�ects the di�erence in total nonfarm payroll employment between February 2020 and March 2022. Bureau of Labor Statistics via Haver Analytics. In�ation Monetary Policy Receive an email noti�cation when News is posted online: By submitting this form you agree to the Email Address Subscribe (804) 697-8956 (804) 332-0207 (mobile) © 1997-2024 Federal Reserve Bank of Richmond

Tom Barkin (2022, April 11). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20220412_tom_barkin

@misc{wtfs_regional_speeche_20220412_tom_barkin,
  author = {Tom Barkin},
  title = {Regional President Speech},
  year = {2022},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20220412_tom_barkin},
  note = {Retrieved via When the Fed Speaks corpus}
}