Philadelphia Fed optimistic about US economic resilience

Central bankers point to encouraging signs amid slowing labour markets

The US economy is showing surprising signs of resilience. That was the diagnosis made during OMFIF’s meeting with the Federal Reserve Bank of Philadelphia. Featuring Philadelphia Fed Chair Patrick Harker, as well as members of financial institutions, central banks and other regional Fed banks, discussions ranged from the state of the US economy to the prospect for subsequent interest rate hikes and general predictions about strategies for reducing inflation and spurring sustainable growth.

Debates about US monetary policy deliberations are often marked by two competing and politicised notions of American economic health. One camp argues that US labour markets signal surprising dynamism amid challenging conditions. The other argues that signs of an economy under strain are beginning to emerge – as seen from a string of bank collapses and rising symptoms of debt distress among American households.

Central bank representatives at the meeting were unanimous in their belief that the US economy was performing well – perhaps, surprisingly well. Kartik Athreya, executive vice president and director of research at the Federal Reserve Bank of Richmond, Chiara Scotti, senior vice president and research director at the Federal Reserve Bank of Dallas, and Joseph Gruber, executive vice president and director of research at the Federal Reserve Bank of Kansas City, echoed Harker’s position that the US economy has been ‘incredibly resilient’. They agreed that ‘big picture, the economy navigated extraordinarily well in the context of the pandemic’.

With these perceptions of economic dynamism, central bankers may now focus their attention more acutely on fighting inflation. Yet despite signs of inflation improving, Harker noted that ‘there is still a need to get it right’, as the precise causes of inflation are subject to further debate marked by similar politicisation.

Harker remarked that labour has played an important role in increasing inflation. Gruber concurred, arguing that, ‘while energy prices are high’, they are surpassed by ‘persistent inflation of core prices’ driven by ‘demand outstripping the economy’s ability to provide goods and services’. Instead, both Harker and Gruber pointed to low unemployment and wage gains, in addition to the impact of household balance sheets being bolstered by pandemic stimulus provisions.

The findings of a study by Ben Bernanke and Olivier Blanchard support this (Figure 1). They conclude that shortages induced by Covid-19, coupled with growth in energy prices as a consequence of the Russia-Ukraine conflict, were instrumental in kindling the initial ascent of inflationary pressure. Yet they argue that the increase of demand abetted by Covid-19 stimulus, along with difficulty in filling labour market vacancies, has allowed price growth to persist, even as energy and supply shocks wane.

Scotti remarked at the meeting that the stimulus measures primarily impacted the spending habits of lower-income households and that many economists underestimated the extent to which such cash transfers would impact their expenditure.

Figure 1. Covid-19 factors were instrumental to increased inflationary pressure

Source: The Wall Street Journal

For Harker and other participants at the Philadelphia Fed meeting, the slowdown of labour market hiring was a welcome sign. Although Harker commented that he is ‘not forecasting a recession’ and that the US economy remains foundationally strong, he does see signs of a general slowing.

He said that unemployment may increase until the US eventually reverts to 2% gross domestic product growth. But Bernanke and Blanchard estimate that unemployment would need to rise to above 4.3% to bring inflation to the Fed’s target. As Harker put it, arguing in favour of a ‘skip’ in rate hikes, rather than a pause: ‘We need to cool the labour market, but I don’t think we need to crush it.’

Participants at the event remained largely optimistic in the face of clear disruption. In the long term, Harker pointed to demographic change and the limited worker availability to fill roles in the economy.

He also highlighted the challenges and opportunities brought on by the advent of artificial intelligence. Citing the work of Andrew McAfee and Erik Brynjolfsson, Harker asserted that there will still be ‘a role for human beings’, particularly involving ‘skills that are uniquely human’. He acknowledged the intervention of AI but emphasised the need to ‘double down on complex thinking’ and to ‘change the way young people are educated’. In doing so, the US can use the disruption entailed by demographic and technological change to produce a more stable economy and monetary policy environment.

Julian Jacobs is Senior Economist at OMFIF.

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