Reading the tea leaves is getting tougher under Federal Reserve Chairman Jerome Powell. Its assessment of the balance of risks between unemployment and inflation offer little guidance about the forces that will be acting on policy makers this fall and beyond.
The impulse from lower taxes on consumer spending and gross domestic product growth could peter out next year. Or as supply siders in the White House predict, a lower cost of capital could set off a permanently accelerated pace of capital formation and GDP growth.
The outlook for inflation has never been more uncertain. And we have a chairman who is a lawyer with little rigorous training in economics—a tinker in a land of physicists.
The unemployment-inflation tradeoff has become unglued from the Phillips curve, and it’s important to bear in mind what this means. To dilettantes, the hypothesized inverse association between rates of inflation and unemployment is an empirical relationship that tells us too much economic activity causes prices to rise.
More fundamentally, it’s about the elasticity of the supply of labor, and the latter appears to be very close to zero these days. As headline unemployment falls, the pace of real wage gains hardly seems to budge, because the adult labor-force participation rate remains woefully low.
Hence the headline unemployment rate (the U3) is not the relevant measure of slack in the labor market. The appropriate metric would include the “unemployed” counted in U3 plus those adults on the sidelines not currently looking for work but who could be inspired by higher wages to give up welfare benefits — a very difficult number to estimate.
Also, overseas workers and international labor arbitrage are increasingly important, and a stronger dollar BUXX, -0.13% could easily erase the effects of many Trump tariffs.
For other reasons, the ultimate effects of tariffs on prices of many goods may not sort as initially anticipated. For example, the management at Whirlpool (NYSE:WHR) +0.20% is blaming the steel tariffs for declining profits — even with a recently imposed protective tariff on washing machines—but LG (KS:066570) is expanding capacity.
The Korean company appears to understand the lesson of Bush-era steel tariffs — the initial steel price spike should subside to about half as mothballed and new capacity come on line. Then LG (KS:066570), -1.05% , with a superior product, can undercut Whirlpool by producing here and prices should fall.
When asked about the juxtaposition of the 4.5% Fed estimate of the non-inflationary rate of unemployment and the observed U3 at about 4%, Powell attributed the absence of an inflationary surge mostly to market expectations.
Geez that sounds like the stuff we got on Louis Rukeyser’s “Wall Street Week.”
Over the next several months, the financial editors will continue to give space to stories making alarmist comparisons between monthly consumer prices this year and last. However, remember oil and gas prices fluctuate a lot, and those were depressed last year. The fact is core CPI inflation is very tame—over the last three months the annualized monthly change averaged just 1.8%.
Sorting all the competing forces on inflation—in the oil market, sanctions on Iran and state entropy in Venezuela vs. booming Saudi Arabian and U.S shale production, and the supply-chain consequences of tariffs vs. a stronger dollar — it’s very tough for the trained macroeconomists who advise Chairman Powell to tell him what he should tell us about the outlook.
Those macroeconomists tend to view folks who specialize in industry economics as the intellectually less fortunate who should to be banished from prestige positions at the Fed to the bowels of the Commerce Department. And Powell, unlike his predecessors, spends a lot of his energy on Capitol Hill massaging the expectations of politicians who could become his critics if he stumbles.
The chairman is like the history professor pressed into service to teach a 20th century American novel class by an unforeseen absence in the English Department. He may remember Booth Tarkington wrote “The Magnificent Ambersons” — I bet Powell even has his very own copy of Keynes’s “General Theory” —but he relies on Masterplots or the yellowed lecture notes of an overworked colleague to get through the semester.
With all this going on, looking to Fed statements for the outlook about inflation and interest rates six months from now is like reading the Las Vegas betting line for the 2019 Super Bowl Champion in January.
It may be the Patriots or it may not.