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Posts from the ‘Money & Monetary Policy’ Category

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Money Talks Illustration by Oliver Munday, The New Yorker

GDP grew more than expected last quarter, jobless claims remain low, and one survey-based index says manufacturing activity hit a three-year high in July. Here are a few other stories from the week’s economic news:

  • The verdict on the July jobs report is that it was a “mild disappointment.” Non-farm payroll employment rose by 209,000 last month, below gains of 298,000 in June and 229,000 in May. Since the start of the year, the labor force has grown by an average of 126,000 people per month. Over the same period, job gains have averaged 230,000 per month. If sustained, that difference is enough to keep the unemployment rate falling by more than 0.1 point per month. The unemployment rate did nudge up a bit in July, to 6.2 percent from 6.1 percent, but that follows an outsized 0.6-point drop between March to June. While unemployment is down from a peak of 10.0 percent during the recession, Justin Wolfers, writing for the Upshot, says it is still way too high. Wolfers observes that if you were to line up all the unemployed people in the country, they would stretch from New York to San Francisco. That is a striking visual, but what does it mean for the economy? Following the recession, unemployment peaked at 15 million people. That number is down to 9.7 million now, but it is still higher than the low of 6.8 million prior to the recession. AIER’s Business-Cycle Conditions analysis suggests the economy will strengthen in the second half of the year, which should keep the employment picture improving.

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Should Local Currencies Be Regulated Like Cryptocurrencies?

The rising popularity of virtual cryptocurrencies, basically mediums of exchange built on the principles of cryptology, has caused U.S. regulators to take their directive more seriously. Concerns over nefarious uses such as money laundering led the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) to issue “Guidance on Virtual Currencies and Regulatory Responsibilities” on March 18, 2013.

This guidance was intended to provide “clarity and regulatory certainty for business and individuals engaged in an expanding field of financial activity.” Not surprisingly, it did just the opposite, creating confusion and uncertainty for regulators who do not yet know how to apply the guidance to the multitude of currencies that are developing. In addition, the regulations, which were designed with virtual currencies in mind, are having an unanticipated effect on local currencies.

The small non-profit organizations that manage place-based currencies are concerned that the regulations will place an undue administrative and financial burden on their small programs. In essence, the “guidance” appears to broaden the definition of what is considered a money service business with attendant filing requirements and regulatory hoops.

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Three Takeaways from the April Employment Report

The monthly Employment Situation Report for April from the Bureau of Labor Statistics was followed up by a deluge of press coverage. How can you make sense of the data itself, let alone the cacophony in the press? We have three key takeaways for you:

1) A tightening labor market doesn’t seem to be sparking inflation.

The overall unemployment rate plunged to 6.3 percent in April from 6.7 percent in March. Economists agree that the unemployment rate affects inflation, but they disagree about the nature of that relationship. The Fed estimates the lowest the unemployment rate can go without causing accelerating inflation is about 5.5 percent. But a recent flurry of research suggests it’s the short-term unemployment rate, covering workers unemployed for fewer than six months, that affects inflation, because those out of a job for longer than six months are on the “margins” of the labor market.

That short-term rate fell to 4.1 percent in April from 4.3 percent in March. It has been falling steadily since the end of the recession, and it’s quickly closing in on the pre-recession low of 3.7 percent. Does that mean we should be bracing for a surge in wages, with inflation hot on its heels? Perhaps not: Earlier this week, the employment cost index was reported up only 1.8 percent compared to a year ago in the first quarter, slowing from a 2.0 percent pace in the fourth quarter. For the last four years, the index has been pretty rock solid, wobbling in a tight range between 1.7 and 2.0 percent. No upward pressure there. Meanwhile, the core PCE price index—one of the Fed’s key inflation measures—rose just 1.2 percent compared to a year ago in March. That’s up slightly from 1.1 percent in January and February but far from the 2.4 percent peak pace seen before the recession.

The short-term unemployment rate may have been a better guide to inflation pressures than the overall unemployment rate in the past, but a seemingly rock-bottom short-term rate now isn’t lighting any fires under wages or prices.

2) There may not be any hidden slack in the labor market.

Perhaps we’re not seeing bigger wage gains as unemployment falls because there’s still a lot of “slack” in the labor market. That has been Fed Chair Yellen’s view—you can see our updated “Dashboard” of her key labor market indicators here.

One of Yellen’s theories is that the deep recession caused many unemployed workers to drop out of the labor force altogether. If that’s correct, we should see the labor force participation rate rebound as the economy recovers. But that may be wishful thinking. The participation rate has been declining steadily since the end of the recession, from 65.2 percent in January 2010 to just 62.8 percent in April. While it seemed to have stabilized earlier this year, it ticked down again in April by nearly half a percentage point. That’s the main reason for the big drop in the unemployment rate in April.

As we have been discussing in our Business Cycle Conditions report, the economy is on a slow-but-steady recovery path. Perhaps it’s unwise to expect any big swings in labor market trends this far into the recovery. 

3) Noisy data affect perceptions, but so do revisions.

Along with new data showing a smoking 288,000 gain in non-farm payrolls in April, today’s report included a total of 36,000 in upward revisions to the March and April numbers, to 203,000 and 222,000 respectively. Revisions so far this year have netted a 30,000 gain compared to initially reported results. Last year, net revisions resulted in a 31,000 gain, on average.

The New York Times yesterday ran a compelling bit of analysis that illustrates why people shouldn’t get worked up over month-to-month changes in payrolls, which are mostly just “noise.” But you should also keep in mind that the payrolls numbers we see today will definitely not be the numbers we’re looking at next month, or a year from now.

Our animated chart below shows the initially reported payrolls data over the last year versus the latest reported numbers. Animation may take a few seconds to load.

Nonfarm Payrolls

CPI’s History Is Not Just About Bureaucrats

Every month, the Bureau of Labor Statistics releases the Consumer Price Index to a wide range of commentary. Policymakers often debate whether the CPI accurately measures inflation. But you might be interested to know that the history of the CPI is not simply about bureaucrats sitting in an office on the Potomac. In fact, the CPI has its roots in important economic and political events of the late 19th and early 20th century.

The precursor to the CPI was an in-depth report on the 1890 McKinley Tariff, which raised import duties to an astronomical 50 percent. The tariff was meant to protect U.S. industries but in the end hurt consumers in the form of higher prices. Early work measuring price inflation ultimately led to the repeal of the McKinley Tariff to the benefit of the consumer.

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Good but not Great: Our View of the March Employment Report

The March Employment Situation showed improvement in hiring and hours worked, reflecting a rebound from weather-distorted data in January and February. There were also upward revisions to the prior month’s jobs numbers, adding an additional 37,000 to payrolls. For the private sector, payrolls rose 192,000 in March, bringing the three-month average to 182,000, just slightly below the 12-month average of 189,000.

On the negative side, hourly wages fell 0.1 percent for the month, putting the year-over-year gains at just 2.2 percent. Faster wage gains are the key to improving consumer confidence and accelerating consumer spending. The aggregate payrolls index, which combines employment, hours, and wages, rose 1.0 percent in March and is up 4.0 percent for the quarter – in line with growth over the past few years. The rise in the payrolls index points to continued moderate growth in personal income, which in turn should support moderate gains in consumer spending.

In total, the report suggests that the first quarter ended with improving, though not great, momentum, and this positive momentum will likely carryover into second quarter GDP growth. These results are consistent with the results of AIER’s on-going business indicators analysis.

However, many of the gauges on the Yellen dashboard – particularly broader measures of unemployment and the number of marginally attached, discouraged, and involuntary part-time employees – remain weak. With the outlook for growth still considered to be below trend, and with inflation measures running below the Fed’s target, the Fed is unlikely to change the course of monetary policy based on this report.


What’s on Janet Yellen’s Dashboard?

The Federal Reserve’s Federal Open Market Committee (FOMC) this week changed its “forward guidance” on monetary policy, dropping its 6.5 percent unemployment rate “threshold” for considering an increase in the federal funds target rate. Previously, the Fed had said that it would keep its key interest rate target near zero “at least as long as” the unemployment rate remained above 6.5 percent, then “well past the time” it declined below 6.5 percent. The unemployment rate is currently 6.7 percent.

Explaining the move, Chair Janet Yellen said that as the economy comes closer to achieving full employment, the FOMC will have a more finely balanced decision about when and by how much to raise the target for short-term interest rates. So what will the Fed, and Ms. Yellen, be looking at to assess labor market conditions? In her press conference, Ms. Yellen listed a “dashboard” of indicators that she watches to gauge the progress the labor market has made in its recovery from the Great Recession. We have represented those indicators in a series of six charts, so you can get a sense of the trends and lingering troubles Ms. Yellen has her eye on.

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Temperature is a measurement of the average kinetic energy of the molecules in an object or system. The higher the temperature, the more rapidly the atoms within the material move. Conversely, the colder the temperature, the slower the atoms move.

The cold weather experienced across many parts of the U.S. over the past few months has likely had a similar effect on the economy–slowing down activity. Our Business-Cycle Conditions (BCC) indicators reflect the effects of severe weather on the economy. The percentage of our leading indicators that expanded in February fell to 67 percent following four months at 100 percent. That’s the lowest reading since September 2009. Notably, the percentage of leaders expanding is still above 50 percent–meaning that more than half of our leading indicators still suggest ongoing economic growth.

So how will the slowing economy affect Fed officials’ outlook for the labor market and inflation, and therefore future policy? Federal Reserve Chair Janet Yellen stated last month that Fed officials suspect “unseasonably cold weather has played some role” in the recent softening in economic indicators, but she voiced uncertainty over how much.

Likewise, Philadelphia Fed President Plosser said, “We may not get a good handle on the economy for a few months and even then we’ll still be uncertain as we always are.”

At AIER, we continue to believe that recent weakness in the economy is weather related. Therefore, we expect the economy to gradually re-accelerate and for Fed officials to follow through on their stated guidance of continuing to taper asset purchases in measured steps.

Rich Uncle Pennybags

Media abounds with articles varying around the theme of “Why This Market Has Room to Run.” Equity market bulls enthusiastically point out that corporate profits have reached an all-time high and continue to grow. This acts as evidence that historical valuations are no longer meaningful. Corporate profits have, in fact, shown an upward trend during the last 30 years. This phenomenon led to the commentary in this month’s inflation report.

Consumer prices are ultimately a function of labor costs, raw material costs, and profit margins. As many commodities prices have trended down in the last two years, companies faced a business decision: drop prices in an effort to capture market share or maintain prices and effectively increase margins. At the aggregate level, it seems companies have largely decided to choose the latter and bolster profit margins.

Businesses and executives have short-term incentives to drive profit margins higher as long as the consumer is willing to accept them. When raw material prices increase, the prices may be passed along the value chain to the end consumer. But when raw materials decrease in cost, as has been the recent case, companies are not likely to pass along the savings unless competitive forces command it. Increasing margins have encouraged stock prices upward, lining the pockets of stockholders and executives. When a business increases margins it means “ker-ching” for Mr. and Ms. CEO.

A July 2013 Business Inflation Expectations Survey from the Atlanta Fed asked businesses how they would respond to a ten percent increase or decrease in raw materials costs. The survey found that a decrease in costs would be met with decreased consumer prices for about 25 percent of businesses. On the other hand, an increase in costs would be met with increased prices for about 52 percent of businesses. Increased costs are passed along to the consumer, but savings are not.

Don’t Panic over GDP Revision

GDPAmong the things you should worry about, the downward revision to fourth quarter GDP growth reported by the Commerce Department should not be high on the list. The latest estimate puts the annualized growth rate at 2.4 percent, down from 3.2 percent in the advance estimate released in January.

Looking at the details, downward revisions were made to the estimates for consumer spending, exports, and state and local government spending. Partially offsetting those downward revisions was a significant mark-up to the growth rate of business fixed investment, to a 7.3 percent pace from 3.8 percent.

The news of weaker fourth quarter GDP comes on the heels of a series of sluggish economic reports, which analysts have largely attributed to the effects of prolonged severe weather across much of the country. Fed Chair Yellen addressed the issue in congressional testimony yesterday, noting, “We will try to get a firmer handle on exactly how much of the soft data can be explained by the weather and how much is due to a softer outlook.”

The downward revision to GDP growth raises concerns in some quarters that the economy had already begun to soften in the fourth quarter—corresponding to the months of October, November, and December—before severe weather hit in December, January, and February. But keep in mind that the government shutdown at the start of the quarter, in October, directly subtracted 0.3 percentage points from GDP growth through the government spending component. The extent of the impact of severe weather effects at the end of the quarter, in December, is harder to quantify. Without those two exogenous factors, though, we likely would have seen significantly stronger GDP growth last quarter.

There is no indication that the underlying trend in the economy has weakened substantially. A key measure of domestic demand, real final sales to private domestic purchasers, rose 2.8 percent in the fourth quarter, just below the four-year average growth rate of 3.0 percent. This suggests that domestic demand remains resilient. What’s more, the latest reading on AIER’s latest Business-Cycle Conditions (BCC) indicators points to “strong economic momentum” at the end of 2013.

So we believe that transient factors were largely responsible for the fourth quarter slowing of GDP, and that the improving underlying trend will reassert itself in coming months.

That said, first quarter GDP results are unlikely to be spectacular given the severe weather events in January and February—and we have yet to see what mother nature will bring us in March. But a catch-up in economic activity from weather-depressed levels early in the first quarter should be forthcoming.

With the underlying economy likely to stay on an improving track, we expect monetary policy to stay on course as well, with the Fed likely to continue to taper its large-scale asset purchase program over the next several meetings. For more on Fed policy and AIER’s economic outlook, stay tuned for our upcoming BCC report, due out next week.

[Photo: Flickr/NCPA]

Daily Inflation Surges

Another month of ho-hum inflation in December left the CPI annual figure at 1.5 percent, on the low end of the historical spectrum but squarely within the typical annual range.

The new year, however, has seen inflation as measured by daily metrics surge to a 0.4 percent monthly rate, the highest since April 2013. This is likely the effect of arctic temperatures across the country pushing natural gas energy prices upward. As the demand for home heating fuels has surged, so have prices.

02/2014 Inflation Report Moneyness

Our most recent Inflation Report coined a term, moneyness, meant to describe the potency that money exerts as it flows through the economy. Moneyness is a concept that helps us understand the ability of money to fuel the economy.

Economists use two primary metrics to measure the speed and magnitude at which money moves through the economy: the “money multiplier” and the “velocity of money.” The money multiplier measures how often a dollar gets loaned. Money velocity measures how quickly money moves in and out of consumers’ pockets. Both of these measures are at historically low levels. Moneyness just isn’t what it used to be.

Moneyness tends to be a slow-moving metric, one that we would expect to take several quarters to really turn around. But the recent spike in daily inflation reiterates that no economy is immune to inflation. Prices are, after all, subject to the laws of supply and demand.

In the case of home heating fuels, demand has experienced a shock, causing prices to rise dramatically.

Please see our February Inflation Report for a full explanation of moneyness and a historical perspective on inflation.