Tom Barkin

I thought today I might share some quick perspectives on the economy, and then dig in on a topic generating much interest: the question of inflation. These thoughts are my own and not those of the Federal Open Market Committee or the Federal Reserve System. That frees me up to be as direct as I want, and I’m looking forward to hearing your questions and comments. My background is business, not research, so I hope you find my views and experience relevant.¹

I’d like to start with the big picture before turning to the latest data. Economic activity fell off a cliff in March and April as we shut down, increased rapidly in May and early June as the economy reopened, and then began to flatten in late June and July as the virus resurged. Over the last month, the virus has receded somewhat, though cases remain at elevated levels while the death rate has dropped. Vaccines are becoming more proximate, but their rollout and effectiveness are still hard to predict. Recent data posts, most notably the jobs report, have surprised on the upside. Congress has failed to pass another stimulus measure, creating risks to the less fortunate — though to be fair we haven’t yet seen that impact in the numbers. 

So where are we then? Given the steepness of the drop, trying to interpret the rebound in growth rates is confusing. I prefer to talk levels not rates: where are we today versus where we were pre-COVID-19. The unemployment rate is 8.4 percent, up from 3.5 percent in February. Nearly 12 million fewer Americans are employed, a drop of 7.6 percent. Spending is coming back faster than employment. Real Personal Consumption Expenditures (PCE) — 68 percent of the economy — is down 4.8 percent from its January peak. Within that, spending on goods is actually up 6.4 percent, but services spending is still down 9.7 percent. Our best proxy for business investment, new orders of nondefense capital goods excluding aircraft, is down 0.5 percent since February, though it was lagging at that time. And of course, government spending is up 53.7 percent as fiscal policy has attempted to bridge the downturn. 

But today I want to focus on a question I’ve been getting a lot these days: Are we at risk of seeing escalating inflation? If you focus on the data, this question is a bit surprising. The Fed’s inflation target is 2 percent. Over the last 20 years, headline PCE inflation has been 1.8 percent. Over the last 10 years, 1.5 percent. Over the last year, 1.3 percent. Over the last 6 months, 1 percent.  It certainly hasn’t been escalating so far.

If anything, financial markets seem more concerned about low inflation, not high. TIPS breakevens fell from 2.3 percent in 2007 to 1.6 percent today and were even lower a couple of months ago.

On the other hand, I can understand why people might expect that higher inflation is on the horizon.

Some people worry about the actions the Fed has taken in response to the COVID-19 pandemic. After declining post the global financial crisis, the size of our balance sheet has surged to unprecedented levels, from $4.5 trillion to $7 trillion. As a result, M2 has expanded. To the casual observer, the actions the Fed has taken in recent months might look like the kind of “money printing” that has historically been associated with inflation.

The Fed has also lowered interest rates to near zero and has pledged to keep them there for a long time. As Chair Powell said in a recent press conference, “We’re not even thinking about thinking about raising rates.” Our recent changes to our monetary policy framework and our recent statement support modest overshoots of our target to bolster inflation expectations. While this guidance should help support economic recovery, some might fear that it could de-anchor inflation expectations.

Like the Fed, the federal government has also taken unprecedented action in response to the pandemic.

Congress passed a $2 trillion stimulus package in March, and lawmakers continue to debate further stimulus. Federal debt has risen to its highest levels since World War II. Fiscal spending could pressure prices, and, at some point, mounting government debt could trigger inflation if investors begin to believe that the Fed will not raise interest rates when necessary.

On the consumer side, households have witnessed supply constraints firsthand for food and household items, leading to higher prices at the grocery store, for example. Indeed, according to the University of Michigan’s Survey of Consumers, inflation expectations ticked up from 2.1 percent in April to 3.2 percent in May. While they have declined to 2.7 percent in the preliminary September results, that’s still high relative to the past few years. The core consumer price index has expanded at a 5.1 percent annual rate in the last three months. And one could imagine an inflationary scenario — perhaps with the rollout of an effective vaccine — where demand comes roaring back at a time when supply is still constrained.

Even though it was 45 years ago, many of the people I talk to are part of the generation that still remembers the Great Inflation of the 1970s. So I can understand how, with that perspective, all of these things might be alarming.

That said, I see the recent tick up as just a natural rebound from a deflationary second quarter. And, while it is certainly possible that inflation could escalate in the near future, I have to say I’m less worried about that possibility. 

In 2008, the Fed began paying interest on the reserves it issues. That change means that a larger balance sheet doesn’t have the inflationary impact that it might have in the past. Instead, think of it as merely a reduction in the maturity of outstanding government debt, as the Fed issues short-term debt in exchange for longer-term debt. That’s quite different than “printing money.” And, our surveys show that banks are tightening standards, so there is little evidence that the increase in reserves is fueling an explosion in loans.

On the fiscal side, the saving rate in the second quarter was 26 percent and still 18 percent in July (vs. 8 percent pre-crisis), suggesting that fiscal stimulus isn’t yet overwhelming supply. And recent experience internationally has taught us that our capacity to take on additional debt may be higher than we previously thought.

The last global recession was similarly accompanied by fears of inflation from fiscal and unconventional monetary stimulus. Instead, we saw low and stable inflation here, in Europe, and in Japan. What might explain this?

In today’s environment of stable inflation expectations, I see moderate inflation driven largely by market power and price transparency. Greater price transparency facilitated by the internet may have increased consumer price elasticity and thereby dampened the responsiveness of inflation to resource pressures. At the same time, the rise of national low-price retailers and nonmarket purchasers, who leverage very aggressive professional purchasing disciplines and global alternatives, has made sellers hesitant to raise prices. Economist Thomas Philippon’s recent book on declining competition in America is compelling, but he really only talks about purchasing power in a labor context.² I actually think it has even more impact on the price of goods. 

Still, if these forces dissipate (say through deglobalization or antitrust) or if inflation does start to rise despite these forces, the Fed has proven effective tools to fight it. We may be limited in lowering rates below zero, but we do not face the same constraint when it comes to raising rates to respond to inflation should it appear. 

As you know, the recent focus of our profession has actually been to try to create a little more inflation, not less. And I would count myself among those who think a little more is welcome so that we don’t continue to be persistently below target and perhaps reduce expectations going forward. Our recent revision of our long-run monetary policy framework was in part intended to find ways to boost inflation and inflation expectations a bit.³ I try to be humble about our ability to impact inflation, given the market forces I’ve described. So, as I evaluated these changes, I always asked myself whether the medicine was worth the pain.

While inflation has run below our 2 percent target, as I said earlier, it is not that far-off target; with rounding, you could even call it on target. Moreover, inflation expectations are stable and well anchored. Monetary policy doesn’t operate with precision, so efforts to create a little more inflation do risk de-anchoring expectations and taking us higher than we want to go. That’s why I like where we landed in our new framework, making clear our willingness to have an overshoot — but only a moderate one. Wednesday’s statement reinforces that message. I think that moderation limits the risk of de-anchoring while sending a positive signal on inflation.

Of course, our review also considered aggressive versions of makeup strategies where the Fed commits to a formula to make up for periods where inflation has been below target. You’ll note that our language “average ... over time” permits us to look at our longer-term track record, while the Chairman has made clear we are not committing to a precise formula. I’m happy with that balance, as I remain skeptical of formulaic commitments. Such commitments depend heavily on the central bank’s credibility to bind their successors to suboptimal decisions in the future. Unlike Snape’s commitment in Harry Potter, monetary policy doesn’t have an “unbreakable vow.”⁴

I also welcome the acknowledgement in our framework that meeting our mandate requires a stable financial system. Holding rates low for a long time also can have negative consequences. It generates “reach for yield” behaviors that can lead to market volatility. It narrows the interest rate spread that so many community banks depend on. It can lead to excess leverage, since borrowing is cheap, which could make future financial contractions more painful.⁵ So I don’t see “lower for longer” as “zero forever” and am hoping that we can move toward normalization when the time is right. And if risks arise, last week’s statement gives us freedom to act.  

Thinking more broadly, I want to emphasize that, for now, I remain focused on unemployment, given the huge gap between where we are today and our target. As we learned from the Fed Listens sessions, the public doesn’t see raising inflation as an urgent concern, and I agree with those who see our new framework as evolution, not revolution. Luckily, at a time when we are missing both targets, there is no conflict in giving maximum stimulus, as we’re doing today.

I am hopeful our new framework will be of value. As we implement it, I’m personally committed to being opportunistic. When inflation nears or slightly exceeds 2 percent, I hope to celebrate it and not be too hasty to quash it.

I’m also committed to being optimistic. Industry takes its cue from us. If we persist in pursuing 2 percent and show confidence in our capabilities, price setters will follow. In contrast, the more we bemoan any lack of success — and remember I remain humble about our capabilities — the more impetus we give them to push purchased prices down. Recognizing the risk that I’m doing just that, I commit to tearing up this speech when we’re done.

And for those who continue to worry about whether inflation will explode, I guess I come back to a few key thoughts. It hasn’t yet. It didn’t after the last downturn, despite similar concerns in the United States, Europe, and Japan. Powerful market forces have been helping keep it in check, and I don’t anticipate that they will dissipate anytime soon. And should inflation emerge, the Fed has the tools and the will to address it.

Thanks, and I’ll now open it up for questions and comments.