Regional President Speech

Home / News / Speeches / Thomas I Barkin / 2022 Prince William Chamber of Commerce Potomac Science Center - GMU Woodbridge, Va. • We are grappling with high, broad-based and persistent in�ation. It is worth asking: what happened? • It’s part COVID and supply imbalances. It’s part �scal. And it’s part monetary. Movements in any of these factors could have quieted in�ation somewhat. But I’m not convinced any one of them is the whole story. For me, it’s the accumulation of so many in�ationary pressures at once that likely tells the tale. • The question is how long this can last. Persistence is the essence of in�ation. Business leaders still see it as an episode, not a regime change. The water in the river may be high but it hasn’t yet breached the dam the Fed built to keep in�ation expectations in line with our 2 percent target. • In�ation should come down. But I don’t expect its drop to be immediate nor predictable. We’ve been through multiple shocks, and signi�cant shocks simply take time to dampen. • The Fed has the tools to bring in�ation down and will persist until it does. Thanks for having me. Today, I want to talk about the economy, but I also want to take a step back and re�ect on how we got here and where we might be headed. These views are mine alone and not necessarily those of anyone else in the Federal Reserve System. I think you all know where the economy is today. We’ve seen a historically strong recovery from the short but deep 2020 recession. GDP surpassed its pre-pandemic level in the �rst quarter of 2021. Employment did so in August of this year, and the unemployment rate has basically come back to its low pre-COVID levels. While there is a lot of talk about a recession, the strength of the labor market suggests that is still premature. But, despite the good news that the worst of the virus seems behind us, we have not yet returned to normal. Supply chains remain strained as �rms struggle to meet ever-shifting levels of demand with unstable production capacity. Employers are short workers, partly due to lower immigration and excess retirements. The war in Ukraine and widespread drought conditions are a�ecting commodity supply. And, of course, for the �rst time in a generation, we are grappling with high, broad-based and persistent in�ation. The Consumer Price Index is at 8.3 percent. The Fed’s preferred metric, the Personal Consumption Expenditures Price Index, is 6.2 percent headline and 4.9 percent core. Both are near 40-year highs. The resurgence of in�ation is particularly noteworthy. Before the pandemic, we had decades of remarkably low and stable in�ation. I give my Fed predecessors credit for that – a lot of work went into reducing in�ation and stabilizing in�ation expectations. So, it is worth asking: What happened? How did we end up in an in�ationary environment most wouldn’t have imagined just three years ago? I thought I’d share my views, but I look forward to hearing yours as well. Supply Shocks I start with the main story of the past few years: COVID-19. The pandemic (and the responses to it) unleashed a series of physical and human supply shocks that have pushed prices and wages up and lasted far longer than anyone anticipated. On the physical side, lockdowns shifted spending from services to goods, especially those related to time at home. Then, reopening with a successful vaccine unleashed demand. Manufacturers were unable to keep up; they struggled to forecast and to operate their complex supply chains. Transportation networks became overwhelmed. Houses were in short supply. The services sector was plagued with supply shortages too: They couldn’t �nd enough chicken wings, popcorn buckets or replacement car parts. Both the goods and services sectors also dealt with labor supply shocks. At �rst, the issue was sick or quarantined workers. But the direct health impact was not the only problem. Immigration dropped. Child care and elder care responsibilities ballooned. Retirements were pulled forward. Health fears stuck around. So, even once COVID protocols lifted, many businesses couldn’t operate at pre-pandemic capacity. Restaurant service is still an issue. And today, employers are struggling with productivity as they try to train new workers. Both shocks have been surprisingly persistent. I thought as soon as vaccines were available, schools reopened and enhanced unemployment ended, people would return to the labor market. I thought chips would be in cars by now. I should probably also mention non-pandemic supply shocks, as there have been quite a few. There was the severe winter storm in Texas, the �re at a chip plant in Japan, the ship lodged in the Suez Canal, the bird �u outbreak and then, in case things were feeling too calm, Russia’s invasion of Ukraine. In normal times, each might have had only a �eeting impact on in�ation. But during COVID, each piled on more price pressure. So, supply shocks are clearly part of the story. But, as I’ll discuss further in a moment, the challenges went beyond supply. For goods like durables, apparel and pet supplies, demand remains much higher than pre-pandemic levels. Furthermore, in�ation has broadened beyond supply chain-a�ected sectors; it now seems to be hitting virtually every single one. For most of us, COVID seems e�ectively over and a number of these supply shocks have passed. If supply was the issue, why hasn’t in�ation settled by now? Fiscal Fuel That brings us to �scal policy. Six trillion dollars of stimulus was passed, fueling demand and limiting labor supply. Six trillion is a lot of money. It supported programs like stimulus checks and eviction pauses. It supercharged demand, particularly from the segments of our economy with the highest marginal propensity to consume. The PPP helped keep businesses a�oat, but it also sustained worker demand that might otherwise have dropped. All these programs hit the economy at a time when the supply of labor and goods was constrained. Some would additionally argue that ever-expanding �scal de�cits, on the watch of both political parties, are driving in�ation as well. Signi�cant de�cits run the risk of unanchoring in�ation expectations. If people believe government has lost its will to control spending, they could conclude that it has no option but to in�ate its way out of its debt burden. So, current and expected �scal spending is also part of the story. But while overall demand has recovered, it is not elevated in total. Much of the stimulus hasn’t been spent. Americans still have an estimated $1.5 trillion in excess savings, state and local governments still have billions to tap and the infrastructure package will take years to roll out. So, it is hard to pin in�ation entirely on stimulus-fueled demand. Moreover, in�ation is global today. Other countries that did not pursue the same level of �scal response are still dealing with decades-high in�ation. The notable exception is the place with one of the most prominent historic debt burdens: Japan. Money, Money, Money We need then to explore monetary policy and ask whether we would be witnessing this in�ation if the Fed had taken a di�erent approach. You won’t be surprised that I’ve spent a lot of time considering this question. Some point to the dramatic increase in the money supply. Since the start of the pandemic, in the context of government de�cits and asset purchases, M2 grew 40 percent. Milton Friedman famously said that (in the medium term), “In�ation is always and everywhere a monetary phenomenon.” What other proof could we need? Paul Volcker started targeting the money supply in late 1979 but shifted to targeting interest rates as a better policy just three years later. Financial innovation, among other forces, has made money velocity less stable and weakened the relationship between money supply, GDP growth and in�ation. We can see the velocity issue during COVID: M2 velocity fell approximately 25 percent in 2020 — not my de�nition of stability. In the last recovery, when M2 increased nearly 46 percent between 2010 and 2015, we saw �ve-year in�ation fall from 2.2 percent to 1.4 percent. If money supply were the driving force today, we would need to understand why it wasn’t back then. Others argue the Fed was too expansionary for too long — that we were caught o� guard after the prior decade of stubbornly low in�ation. We believed in�ation was temporary, driven by the supply and demand factors discussed earlier. History taught us not to overreact to short-lived supply shocks — it usually doesn’t make sense to constrain the economy to �ght a shock that will go away on its own. But in�ation didn’t fade as we had expected. To be sure, we have learned something for future supply shocks. With perfect hindsight, it would have made sense to have ended asset purchases and raised rates earlier. But sick workers would still have had to stay home. Car manufacturers would still have been short chips. Russian oil and Ukrainian wheat supplies would still have been disrupted. In theory, if monetary policy had been di�erent enough, perhaps it could have made a di�erence. But how much faster would we have had to move to be in a demonstrably di�erent place? Remember that in February 2021, 12-month in�ation was still at 1.7 percent (PCE), nearly 8.8 million fewer people were employed than in February 2020 and unemployment was at 6.2 percent. Here, I think it is worth emphasizing another Friedman insight: Monetary policy works with “long and variable lags.” Our impact is more on the medium to long term than on the short term. So, I take some solace from the fact that medium- and long-term in�ation expectations remain relatively stable as we have now fully engaged in tightening. So, those who are exhausted by in�ation can point �ngers in lots of directions. It’s part COVID and supply imbalances. It’s part �scal. And it’s part monetary. Movements in any of these factors could have quieted in�ation somewhat. But I’m not convinced any one of them is the whole story. For me, it’s the accumulation of so many in�ationary pressures at once that likely tells the tale. In football terms, we �ooded the zone. Before I joined the Fed, I spent 30 years in business. At the Fed, I try to spend my time “on the ground,” understanding how businesses and individuals experience the economy. So, I look at all of this with a real economy lens. Over the past 40 years, in�ation stayed so low and so stable that price and wage increases became an all-but-abandoned lever. Price-setters lost con�dence they could pass costs on to customers; they focused on reducing their own costs instead. Firms employed sophisticated purchasing professionals to �ght suppliers hard on cost increases. Workers grew to expect annual increases in a low and narrow range. In that era of price and wage stability, consumers, quite rationally, were inattentive to in�ation. Now we have seen these intense in�ation pressures accumulate and persist. Perhaps magni�ed in an environment where news travels ever faster, they have moved short-term expectations higher. Massive industry-wide cost pressures pushed suppliers to take the risk of passing cost increases on to customers. Supply shortages gave them con�dence they could weather potential customer attrition. Purchasers, focused on resiliency rather than e�ciency, stopped objecting as much. Investors rewarded companies that passed price increases on and penalized those more reticent. Consumers, funded by stimulus, mostly accepted price increases. Workers gained con�dence in this very tight labor market and negotiated for �exibility or wage increases. Employers desperately adjusted to do what it took to retain and recruit. In short, businesses constrained by a generation of limited pricing power seized the opportunity that arose. Workers emboldened by unprecedented labor market tightness did the same. We all started paying attention. The question is how long this can last. Persistence is the essence of in�ation. When I talk to business leaders, they still view their increased pricing power as temporary. They see it as an episode, not a regime change. To support that, with stimulus being drawn down, you hear more and more stories of consumers trading down or doing without. With recession talk widespread, you hear of labor pressures easing (e.g., recent announcements on return to o�ce). Long-term market measures of in�ation compensation, derived from TIPS indices, remain in line with our 2 percent target despite short-term in�ation and in�ation expectations at multidecade highs. The water in the river may be high, but it hasn’t yet breached the dam the Fed built to keep in�ation expectations in line with our 2 percent target. What does this all mean for where in�ation is headed? First, note that no matter what theory you have on in�ation, you are seeing promising signs. COVID seems to be moving into the rearview mirror. Supply shocks are easing. An index measuring supply chain pressure from the New York Fed has fallen to its lowest level since January 2021. Freight costs have decreased. Some large retailers have announced they are overstocked. Housing seems to be settling. Employers are having more hiring success; more than 3.5 million jobs have been created since the start of the year. And over the last few months, we’ve seen a broad range of commodities drop from peak pricing levels. International developments could further weaken commodity demand. Fiscal stimulus has waned. The projected de�cit is expected to fall from 12.4 percent of GDP in 2021 to 3.9 percent this year (and 3.7 percent next year), according to the Congressional Budget O�ce. And we are seeing the extra savings amassed by consumers being spent down. The personal saving rate has remained below pre-pandemic levels for over six months. For those who still monitor the money supply, it has stayed nearly �at this year, increasing just over 1 percent. And the Fed is moving expeditiously. You’ve likely seen that we have raised rates 300 basis points, started shrinking our balance sheet aggressively and signaled there are more rate increases to come. The transmission of these changes, especially in interest-sensitive sectors, has been rapid. Look at mortgage rates, which in mid-September had more than doubled from a year prior. So, in�ation should come down. But I don’t expect its drop to be immediate nor predictable. We’ve been through multiple shocks, as I’ve discussed, and signi�cant shocks simply take time to dampen. On the business side, I still hear �rms facing wage pressure, especially for merit pay in the face of this year’s cost-of-living pressures. And while margins remain healthy overall, I've heard from many businesses still working to recover costs not yet passed through. On the consumer side, while lower-income consumers are facing stress, higher-income ones seem to be continuing revenge spending. Our rate and balance sheet moves take time to bring in�ation down. But the Fed will persist until they do. One of the key lessons from the ‘70s was not to declare victory prematurely. Perhaps we will get help from supply chain and energy market normalization. But we have the tools to bring in�ation down, even if those disruptions continue. As we do, we should learn even more about the drivers of this episode and how we can avoid any recurrence. Bianchi, Francesco, and Leonardo Melosi. "In�ation as a Fiscal Limit." Federal Reserve Bank of Chicago Working Paper No. 2022-37, August 2022. While in�ation in Japan has recently reached new highs, it is still relatively low compared to global levels. This refers to the percentage change in the consumption velocity of M2 from February 2020 to April 2020. 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, September 29). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20220930_tom_barkin

@misc{wtfs_regional_speeche_20220930_tom_barkin,
  author = {Tom Barkin},
  title = {Regional President Speech},
  year = {2022},
  month = {Sep},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20220930_tom_barkin},
  note = {Retrieved via When the Fed Speaks corpus}
}