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A year ago, in a sharply weakening economy, deflation seemed a credible threat. However, a rebound in energy prices has boosted the Consumer Price Index over the last 12 months. Improvement in the global economy has led to a firming in commodity prices. Despite the diminished threat of deflation, core inflation at the consumer level has trended lower, thanks in large part to weakness in rents (a consequence of residential housing troubles). Policymakers at the Federal Reserve have signaled that economic conditions are likely to warrant exceptionally low interest rates “for an extended period.” Those conditions include an elevated unemployment rate, a low trend in core inflation, and well-anchored inflation expectations. None of that seems likely to change anytime soon.
The Consumer Price Index ex-food & energy is the most common measure of core inflation. Food & energy do matter, of course – and the headline CPI is used to adjust things like Social Security payments – but we are most interested in the underlying trend in inflation. Food and energy prices, being volatile, tend to add a lot of noise. The Fed’s focus has traditionally been on the price deflator for personal consumption expenditures. While the Consumer Price Index is based on a fixed basket of goods and services, the PCE Price Index allows the weightings to change as patterns of consumption change. The core PCE Price Index rose 1.4% in the 12 months ending in January. There are other measures of core inflation. These include median measures (reflecting the middle of price changes) and trimmed-mean measures (which exclude some portion of the highest and lowest price increases each month). All of these measures have been trending at low levels.
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The Federal Reserve has two goals. Price stability and maximum sustainable employment. By “price stability”, we mean low inflation – not zero inflation. Over time, there have been many legislative efforts to change the Fed’s mandate to a signal goal: low inflation. However, there is solid empirical evidence that by keeping inflation low over the long term, job growth will be stronger than it would be otherwise. Yet, while the Fed is firmly committed to keeping inflation low, it is also sensitive to labor market weakness.
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With an elevated unemployment rate, a low trend in core inflation, and steady inflation expectations, there should be no pressing need for the Fed to raise the federal funds rate target. Some of the Fed’s district bank presidents have made hawkish comments, suggesting that rates may need to be hiked sooner rather than later. However, Bernanke is an expert on the Great Depression and realizes the danger of tightening credit too soon (moreover, with consumer and business credit declining, why should the Fed want to tighten credit?).
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Energy prices are a wildcard in the economic outlook. However, recent history suggests that higher oil prices are more of an impediment to economic growth than a catalyst for a higher trend in underlying inflation.
Nonfarm payrolls fell by 36,000 in the advance estimate for February, and would have likely been positive if not for the weather. It’s impossible to estimate precisely the impact that the snowstorms had on payrolls and average weekly hours, but we should see a rebound in the March employment figures. Hiring for the 2010 census is underway, and is expected to peak in May. Unfortunately, those temporary census jobs will be shed in June and the months that follow. Still, looking beyond the impact of the census, job growth is nearly here.
While the housing bubble was the catalyst for economic weakness and excessive leverage in the financial sector was a compounding factor, the most unsettling factor in the recession was the collapse of confidence in the fall of 2008. The thing about panics is that you don’t simply unpanic and get back to normal. It takes a long time for confidence to be restored. Worried about weak economic conditions, firms cut back on capital expenditures and trimmed their workforces. In a way, the worst part of the downturn was a self-fulfilling prophesy.
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Recovering from the depths of the recession was going to take some time. The fiscal stimulus package may not have immediately resulted in employment growth, but it kept job losses from being more severe. Some of the stimulus was cast as aid to the states – effectively, plugging holes – preventing budget shortfalls from causing sharper job cuts. Unfortunately, state budget strains are not going to go away anytime soon. Efforts to reign in state deficits, whether through tax increases or spending cuts, have a contractionary impact on growth.
The fiscal stimulus is currently peaking, but the maximum impact on GDP growth is already behind us. The stimulus has checked the decline in business confidence, but has yet to create much optimism. That will come from improvement in the private-sector economy over time.
The data show that the pace of private-sector job destruction declined significantly over the course of last year. Private-sector payrolls fell by 18,000 in February. That compares to a 707,000 drop in February 2009. If not for the snowstorms, private-sector job growth would likely have been positive last month.
Many schools, government agencies, and businesses were closed temporarily due to the snow (government payrolls fell by 18,000, despite an apparently census-related gain of 16,100 in federal government ex-the U.S. Postal Service). In the establishment series, anyone who works anytime (even an hour) during the survey week (the pay period that includes the 12th of the month) is counted as employed. So not all business closings lead to reductions in official payroll figures.
Last week, Congress worked toward passage of a jobs bill. From an initial target of $80 billion or more, the package was whittled down to $15 billion. That’s not much considering that we’ve lost 8.5 million jobs since the start of the recession. The main part of the bill will be a temporary reduction in payroll taxes paid by employers.
Hiring for the 2010 census has begun. In 2000, census hiring was strongest in March and May. The census will have 800,000 temporary jobs at the peak, although some workers could have more than one job (the largest part, at 635,000, is for the non-response follow-up). How long these workers are employed by the census will depend on the survey response rates. Anti-government sentiment could lead to a higher percentage of non-responses this year. In 2000, temporary census jobs were unwound mostly from June to September.
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Beyond the impact of the census and the pending jobs bill, private-sector job growth should pick up over time. However, the economy still faces a number of serious headwinds, which will likely keep job growth moderate this year.
The recent economic data have been generally weaker than expected, casting some doubt on the prospects for the recovery. However, economic recoveries are not usually associated with steady growth across sectors. Growth is inherently uneven. That means that some economic reports will be strong and some weak – and that is especially true in the current environment, where the economy has to deal with a number of serious headwinds. Economic statistics are also subject to seasonal adjustment difficulties and, as we’re likely to see in much of the February data, the peculiarities of the weather. Bad February weather will not cause a double dip, but it may add to the unease in the financial markets in the near term.
Consumer confidence fell unexpectedly in February. Monthly changes of one or two points in the headline figure are not unusual, but a 10-point plunge is hard to ignore. The details of the report showed that evaluations of current job market conditions remained depressed. In addition, respondents were somewhat more pessimistic about future job availability.
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Consumers don’t spend confidence. Income, wealth, and the ability to borrow are the main drivers of spending. However, the confidence figure is reflective of these drivers (technically, consumer confidence, by itself, does help forecast spending, but if you know income, wealth, and interest rates, consumer confidence doesn’t add much forecasting ability). The drop in consumer confidence likely reflects broad pressures on the household sector. The estimate of 4Q09 GDP growth was revised higher, but that report also showed a downward revision to consumer spending growth and income figures were revised significantly lower back to the third quarter. That income revision implies, all else equal, a somewhat weaker outlook for consumer spending in the near term. Revised figures also show a lower personal savings rate.
The estimate of personal savings is a poor statistic. Savings are not measured directly. They are calculated as a residual (income less taxes and outlays). The savings rate is subject to large revisions. Think back to a few years ago, when it was reported that the savings rate had gone negative. Well, in revisions, that didn’t happen. It would be nice to know what is going on with saving habits. Anecdotally, most households appear to have cut back significantly on their spending. However, the personal savings rate was revised down to 4.1% for the fourth quarter, which seems a bit low. It’s likely that consumers have cut back on spending because their incomes have declined (or grown more slowly).
The savings rate was a key unknown during the economic downturn. If everyone decided to save an extra 5% of their income, we would have a depression. That extra savings implies less spending, and that spending is someone else’s income. Through a multiplier effect, overall demand would be a lot lower and aggregate savings would actually decline (that’s called “the paradox of thrift”). With housing prices and equity investments down, it seems natural that people would be inclined to start saving more for their retirements.
Ultimately, consumer spending growth will be driven mostly by income growth – and income growth depends on jobs. There’s a clear seasonal pattern in private-sector payrolls. Most new hiring occurs between February and June. The jobs data for February are expected to be distorted by the weather. The next few months will tell the tale. Yet, as Fed Chairman Bernanke testified last week, it’s uncertain whether economic growth will be strong enough to generate much growth in jobs this year.
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Investors are not going to get much clarity in the upcoming economic data. Yet, the figures are unlikely to suggest convincingly that we’re off the moderate recovery path.
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