Inflation Alert! Fed Governor Philip N. Jefferson: "if you are willing to widen your lens to include a more commonplace definition, then it is possible to conclude that current monetary policy is, in fact, "on track.""

"The bad news is that there has been little progress on core inflation."

https://www.federalreserve.gov/newsevents/speech/jefferson20230512a.htm

On the Assessment of Current Monetary Policy Governor Philip N. Jefferson At the "How to Get Back on Track: A Policy Conference," Hoover Institution, Stanford, California

Highlights:

"Current inflation is still high."

• "Personal consumption expenditures (PCE) inflation, the black line, stands at 4.2 percent, and core PCE inflation, the red line, stands at 4.6 percent for year-end March 2023."

"Overall, news on inflation so far this year has been mixed."

• "The good news is that food and energy prices both fell in March, and total PCE inflation slowed to 4.2 percent from 5 percent in February."
• "Since peaking last June, inflation has declined about 2.75 percentage points—with nearly all the step-down explained by falling energy prices and slowing food prices."
• "The bad news is that there has been little progress on core inflation."

The drivers of inflation in each of these sectors differ somewhat and understanding the different causes and how they affect the different components can help predict the future course of inflation.

• "Core goods inflation, the red line in the image above has come down since its peak of 7.6 percent in February 2022, but the most recent news has been discouraging."
• "Outside of used motor vehicle prices, which fell unexpectedly in March, disinflation in core goods prices is occurring at a slower pace than expected."
• "Supply and demand imbalances in the goods sector seem to be resolving less quickly than expected."
• "Core housing services inflation, the black line in the image above, surged over the past couple of years as demand in the housing sector underwent a major shift during the pandemic."
• "The latest monthly readings have started to slow, though that is not yet evident in the 12-month changes shown in the image above."

"The recent slowing was presaged by a flattening out of rents on new leases to new tenants since the middle of last year."

• "In contrast, core services excluding housing inflation, the blue dashed line in the image above, has not shown much sign of slowing."

Labor Market and GDP Growth:

• "The April 2023 employment report data continue to point to a strong labor market amid improvements in labor supply, with the prime-age labor force participation rate exceeding its pre-pandemic level."
• "Wage growth has continued to run ahead of the pace consistent with 2 percent inflation and current trends in productivity growth."
• "Wage gains are welcome as long as they are consistent with price stability."
• "Over the 12 months ended in March 2023, the employment cost index (ECI) for total hourly compensation for private-sector workers rose 4.8 percent, down only a little from its peak of 5.5 percent last June."
• "Despite strong growth in consumption spending, gross domestic product (GDP) grew modestly at an annual rate of 1.1 percent in the first quarter of 2023 as inventory investment slowed down substantially, similar to the below-trend pace of growth in 2022."
• "Looking ahead, last quarter's growth in consumer spending seems unsustainable. Indeed, after rising very steeply in January 2023, consumer spending ticked down in February and was flat in March."
• "Moreover, I expect slower consumer spending growth over the remainder of the year in response to tight financial conditions, depressed consumer sentiment, greater uncertainty, and declines in overall household wealth and excess savings."

Recent Stress in the Banking Sector:

• "The tightening in financial conditions we have seen in response to our monetary policy actions is likely to be augmented by the effects on credit conditions from recent strains in the banking sector."
• "The U.S. banking system is sound and resilient."
• "The Federal Reserve, working with other agencies, has taken decisive actions to protect the U.S. economy."
• "Nevertheless, it is reasonable to expect that recent stress events will lead banks to tighten credit standards further."
• "Even though it is too early to tell, my view is that these incremental credit restraints will have a mild retardant effect on economic growth because the recent bank failures were isolated and addressed swiftly by aggressive macro- and micro-prudential policy actions."
• "Nevertheless, I acknowledge that there is significant uncertainty around the amount of tightening of credit conditions in the coming year in response to the bank stress and the magnitude of the effect that tightening might have on the U.S. economy."
• "Therefore, there is some downside risk that the incremental effect of the credit shock is larger than I expect."

Monetary Policymaking and Current Uncertainties:

• "The pandemic aftermath, geopolitical instability, and banking-sector stress have contributed to a highly uncertain economic environment."
• "Additionally, the numerous post-pandemic "surprises" in inflation, employment, and economic growth suggest that the underlying structure of the U.S. economy may be in flux."
• "More simply, the data-generating process for the post-pandemic U.S. macroeconomy is less clear."

"I want to share with you a few strategic principles that are important to me."

"First, policymakers should be ready to react to a wide range of economic conditions with respect to inflation, unemployment, economic growth, and financial stability."

• "The unprecedented pandemic shock is a good reminder that under extraordinary circumstances it will be difficult to formulate precise forecasts in real time."
• "Our dual mandate from the Congress is especially helpful here."
• "It provides the foundation for all our policy decisions."

"Second, policymakers should clearly communicate monetary policy decisions to the public."

• "Our commitment to transparency should be evident to the public, and monetary policy should be conducted in a way that anchors longer-term inflation expectations."

"Third—and this is where I am revealing my passion for econometrics—policymakers should continuously update their priors about how the economy works as new data become available".

• "In other words, it is appropriate to change one's perspective as new facts emerge. In this sense, I am in favor of a Bayesian approach to information processing."

Conclusion

• "The national unemployment rate was 3.6 percent in March 2022 when the current monetary policy tightening cycle began."
• "Today, after 500 basis points of tightening of the policy rate, the national unemployment rate stands at a near-record low of 3.4 percent."
• "At its recent peak, total PCE inflation was 7 percent in June 2022. Currently, it is 4.2 percent in March 2023."
• "Is inflation still too high? Yes. Has the current disinflation been uneven and slower than any of us would like? Yes."
• "But my reading of this evidence is that we are "doing what is necessary or expected" of us."
• "Furthermore, monetary policy affects the economy and inflation with long and varied lags, and the full effects of our rapid tightening are still likely ahead of us. We are balancing the directives of the dual mandate given to us by the U.S. Congress. This is not an easy task in these uncertain times, but I can assure you that I and my colleagues on the FOMC take it quite seriously and with great humility. It is in this sense that I believe that we are well "on track.""

TLDRS:

• "if you are willing to widen your lens to include a more commonplace definition, then it is possible to conclude that current monetary policy is, in fact, "on track.""
• "The bad news is that there has been little progress on core inflation."
• Supply and demand imbalances in the goods sector seem to be resolving less quickly than expected.
• In contrast, core services excluding housing inflation, the blue dashed line in the image above, has not shown much sign of slowing.
• "Wage growth has continued to run ahead of the pace consistent with 2 percent inflation and current trends in productivity growth."
• "The tightening in financial conditions we have seen in response to our monetary policy actions is likely to be augmented by the effects on credit conditions from recent strains in the banking sector."
• "The U.S. banking system is sound and resilient."
• "Nevertheless, it is reasonable to expect that recent stress events will lead banks to tighten credit standards further."
• I acknowledge that there is significant uncertainty around the amount of tightening of credit conditions in the coming year in response to the bank stress and the magnitude of the effect that tightening might have on the U.S. economy."
• "Therefore, there is some downside risk that the incremental effect of the credit shock is larger than I expect."
• "In other words, it is appropriate to change one's perspective as new facts emerge. In this sense, I am in favor of a Bayesian approach to information processing."

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