Follow by Email

Thursday, February 22, 2018

Bernstein: Perspective, people! [feedly]

Perspective, people!

The real risk here is that at some unknown point, we really do hit the economy's capacity limits and instead of more jobs and wages, we just get inflation and higher interest rates. (Michael Nagle/Bloomberg News)

In tracking risks in the current economy, now is a good time to be on alert for two opposing human tendencies: alarmism and non-alarmism. The first calls for perspective. A whiff of inflation, for example, doesn't imply the return of the 1970s inflation monster. Same with interest rates.

There's also a bias that cuts in the other direction: non-alarmism, a.k.a. confirmation or status-quo bias. In this case, one must fearlessly sniff that whiff of inflation and try to evaluate its implications.

The discussion requires looking at pictures of some economic time-series, so let's jump in.

First, here's a great example of how historical perspective should dampen any alarmism. The St. Louis Fed recently tweeted an interesting picture of its index of stress in the financial system, which I show below in the pullout part of the figure (thanks to Somin Park for making all these great figures). You can see the spike at the end of the pullout series and the tweet points out that the index is at a 14-month high. That's useful information, worth keeping an eye on, so no dig at the bank (and one can fit only so much in a tweet).

(St. Louis Fed)

But a look at the full series provides perspective. In the broader scheme of things, the recent spike is a barely perceptible tick. Compared to stress levels in the last recession, it's barely on the radar. And, in fact, and this is important, even looking back at the pullout figure from the tweet, you see similar spikes that faded shortly thereafter.

But to really see the alarmism in the system right now, you must turn to inflation data. The overreaction started with the wage data from the last jobs report. Yes, it popped up a bit, but it's a jumpy series, and we should expect and welcome faster wage growth at this stage of the recovery, which, for the record, is in its ninth year. The concern was that wage growth would bleed into price growth, which would lead to lower corporate profit margins and higher interest rates.

Even though many links in that chain are shaky — the relationship between wage and price growth has weakened considerably in recent years — when the next inflation number came in above expectations, at 0.5 vs. 0.3 percent, alarm bells went off.

But again, context is required. The most informative gauge here — the one to which the Federal Reserve pays most attention — is the core index, year over year, which smooths out both monthly spikes and volatile movements in food and energy prices. The pullout in the figure below shows the monthly bump, but the yearly data show no spike at all, and you can easily see how low inflation remains relative to its sordid past.


Similarly — and this series is particularly important — interest rates have climbed in recent weeks, which again should be expected at this stage of the recovery, especially with a big slug of fiscal stimulus entering the system. But they too remain low by historical standards, with recent similar ups and downs.

(FRED database)

Now, let's flip to status-quo bias and ask if the alarmists are maybe onto something. Although economists cannot accurately assess the degree of slack left in the current economy, we know there's a lot less than there used to be. In that regard, the confluence of low unemployment, slightly faster nominal wage growth and the recent uptick in inflation all make sense. But what threats do they engender?

Faster price growth pushes back on paycheck buying power only if it surpasses nominal wage gains. I'd like to see both growing right now, with nominal wages growth outpacing inflation, especially for lower-paid workers. I recognize the investor class worries about that dynamic crimping corporate profits, but a) for crying out loud, profits have been crushing labor income for years, and b) that fat corporate tax cut will juice after-tax profits.

Higher interest rates could push back on some investing, but remember, the Fed was already raising rates and if they see the market doing their work for them, they'll have no reason to accelerate planned rate increases, at least assuming inflation remains "well-anchored." Here, too, the tax cut significantly lowers the after-tax cost of business investment.

End of the day, nothing alarming is going on in the national numbers, and every reason to press on with the expansion in the hopes that it finally reaches those who catch a break only in high-pressure labor markets. Who knows? Maybe if this keeps up, the black unemployment rate can close more of its four-point gap with the white rate.

That said, all these trends remain on the watch list, especially inflation and interest rates. The latter is of particular concern to me given the unusual fiscal experiment on which we've embarked. Between the tax cut and the spending deal, the government is throwing a whole lot more fiscal stimulus at the economy than it ever has at such low unemployment. In the near term, that's probably a good thing, as it could help reach the folks referenced above (though, especially re the tax cuts, I could have easily found much more direct ways to help them).

The real risk here is that at some unknown point, we really do hit the economy's capacity limits and instead of more jobs and wages, we just get inflation and higher interest rates. Moreover, if interest rates surpass growth rates, a relatively rare occurrence in the U.S. record, our public debt can start to grow quickly.

That, in turn, prompts two negative outcomes: much higher interest payments on the public debt and less perceived fiscal space to do what needs to be done to offset the next recession. If that's how this plays out, it will be ironic indeed. We'll have spent our fiscal stimulus in the recovery instead of the recession.

So stay tuned as I track these indicators, carefully balancing calmness and freak-outs.

Over at WaPo. I left out one figure/point due to space constraints. The other day when the CPI report came out slightly above expectations, as I discuss in the WaPo piece, a few freaker-outers actually started talking about 70's-style stagflation. So here's a graph of how we measured stagflation back in the day, using the "misery index," or unemployment + inflation. Not quite back to 70's levels, I'd say.

Sources: BLS

 -- via my feedly newsfeed