Chicago Fed's Moskow on the Strength of Labor Markets and the Need to Continue Removing Accommodative Policy
If you are looking for news on the course of interest rates, this speech by Chicago Fed president Michael Moskow is fairly hawkish with respect to battling inflation. Combined with the evidence presented at macroblog, it seems a safe bet that rates will continue to rise at a measured pace in the near future unless incoming data alter the economic picture substantially. Many parts of the today's speech are almost identical to the speech Moskow gave on November 15 in which he supported the conclusion that further rate hikes are justified by noting:
- GDP growth is above potential growth
- Much of the slack in the economy has been eliminated
- There are two risks to growth, a slowing of the housing market and high energy prices
- He is not particularly worried about housing since the effects of a decline are slow allowing time for a policy reversal
- He is not particularly worried about energy prices either since they've been higher in the past and are showing signs of moderating
- Inflation is at high end of the comfortable range and inflation expectations are okay for now, but a worry going forward
There were also new parts in today's speech on the strength of the labor market, why it is sometimes necessary in the short-run to increase the interest rate beyond the long-run neutral rate, and longer term economic challenges of maintaining human and physical capital at optimal levels. Here's the part on the strength of the labor market where he spends quite a bit of time trying to convince us that slack in labor markets has been mostly eliminated and that statistics such as labor force participation rates do not alter this view:
U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President: ... The unemployment rate deserves a bit of elaboration. Some analysts question whether that rate accurately reflects the "true" degree of labor market slack. Their concern is that an unusual number of those who want to work may have become so discouraged about their prospects of finding a job that they have given up looking for work. ... Indeed, the labor force participation rate, which is the fraction of the population either working or actively looking for work, is well below where it was prior to the 2001 recession. In contrast, 4 years after the 1990-91 recession, the labor force participation rate had returned to its prerecession level. So the question is, do we think the participation rate will return to its prerecession level? At the Chicago Fed, ... our best judgment is that we will not see a big rebound in participation. This suggests that the current low levels of labor force participation are not indicative of a slack labor market.
First, much of the unusual behavior of labor force participation during this cycle has been caused by a sharp decline in the percentage of teenagers in the labor force. This has occurred at the same time that there have been notable increases in summer school enrollments—a development that is unlikely to be reversed any time soon... Therefore, we don't expect to see teenagers flood back into the labor force. Trends in adult labor force participation are also important. While we have seen large secular increases in women's labor force participation for several decades, this was mostly due to differences in behavior between women born before and after 1960. ... So the increase in women's labor force participation appears to have largely run its course. Men's labor force participation, in contrast, has been declining since the 1950s, and we do not see any reason to expect a strong reversal. Finally, and perhaps most importantly, the aging of the baby boomers is putting downward pressure on labor force participation, because it increases the share of the population that is retired. Putting all these pieces together, I do not expect a large increase in labor force participation. Accordingly, the current unemployment rate is probably close to the level associated with a healthy economy and little labor market slack.
The next new part relative to the previous speech begins with the third sentence where he explains why, in the short-run, it can be necessary to increase the federal funds rate beyond what is required for long-run neutrality:
Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations contained. For me, at this time such policy likely entails further removal of policy accommodation. [start of new part] ... Conceptually, it's easiest to think about the neutral—or equilibrium—rate as being the rate consistent with an economy growing steadily along its potential growth path over a long period of time. ... we're currently near the bottom of this range. Of course, ... we have to recognize that many factors can cause differences between the longer-run concept of neutral policy and what may be neutral policy over the short or medium term. For example, ... [e]ven if the funds rate were at neutral, further changes in policy may be appropriate. ... With inflation at the upper end of my comfort zone, an unexpected increase in inflation would be a serious concern, while a decline in inflation would be beneficial. My views about policy will depend importantly on how these cost factors play out and affect the outlook for inflation. ... or inflation expectations ... What I've just described is the conditionality of monetary policy. As we've said many times, the FOMC will react to changes in economic prospects. Future policy will not be a mechanical reaction to the next number on inflation and employment. ...
This last substantive change is the addition of a section on the longer term challenges of how to maintain sufficient investment in both physical and human capital in with economic issues such as low savings rates and growing budget deficits making this task more difficult:
The risks I've talked about so far primarily relate to the near-term economic outlook. But in the long term, we face a different set of challenges. In order to support productivity growth and maintain a solid trend in economic growth, we need to continue to invest in physical and human capital at sufficiently high rates. In the case of physical investment in plant and equipment, the long-term challenge will be financing. Spending on physical capital must be financed by our national savings... [O]verall national saving has fallen in recent years. Fortunately, the rest of the world has viewed the United States as a good place to invest. ... Unfortunately, such deficits are not sustainable indefinitely. ... This means that if we are to maintain our current rates of capital investment, national saving will have to rise ... This will be happening at the same time that the aging of our population will put increasing pressure on our Social Security and Medicare spending. ... Medicare outlays will account for a rapidly expanding share of the national budget. Without changes in spending or taxes or both, this increased demand for social insurance will further increase government deficits and decrease net national saving.
Finally, another factor that will affect our future economic growth is our ability to improve the quality of our workforce. This requires us to do a better job educating our school age population and providing further opportunities for training and retraining of those already in the workforce. Education has historically been a strength of the United States, but some current trends are worrisome. ...
Given that the economy currently looks healthy, now is a good time to attack some of our longer-term challenges. How we generate increases in national savings and improve education are important issues for our nation. ...