Central bankers struggle to understand modern economics
Why have wages and inflation not gone up despite low unemployment?
Antoinette Schoar, economist and professor of finance at the Massachusetts Institute of Technology (MIT), speaks at the Jackson Hole economic symposium in Wyoming Photograph: David Paul Morris/Bloomberg
Central bankers typically like to project steadfast confidence. But when Jay Powell opened the annual Jackson Hole gathering, the Federal Reserve chair made a surprisingly frank confession.
He acknowledged to his peers that the US central bank has been steering towards higher interest rates with only a hazy sense of direction, and compared the challenges of US monetary policy to “navigating by the stars”.
It “can sound straightforward,” he said. But “guiding policy by the stars in practice. . .has been quite challenging of late because our best assessments of the location of the stars have been changing significantly”.
It was an acknowledgment that underscored the acute difficulties the Fed faces in gauging how far to tighten monetary policy. Mr Powell and his colleagues at the gathering on Friday and Saturday made it clear that the Fed will err firmly on the side of caution as they slowly edge rates higher, while watching for signs of overheating across a range of indicators.
But Mr Powell’s mistrust of central banking lodestars, such as the natural rate of unemployment or neutral rate of interest, speaks to deeper uncertainties running through the profession as officials struggle with basic gaps in their understanding of how the economy works 10 years from the start of the credit crisis.
Among the most stubborn questions is why wages and inflation have failed to ignite despite unemployment falling ever further below what bankers in the US and elsewhere thought was its natural rate.
The topic was at the heart of debate at the meeting organised by the Kansas City Fed, with economists including Princeton’s Alan Krueger, former chairman of Barack Obama’s Council of Economic Advisers, looking for answers outside central bankers’ comfort zones.
Mr Krueger urged officials to ditch models involving perfect competition in the jobs market and dwell instead on workers’ diminished bargaining power in the face of increasingly powerful companies and declining unionisation.
As an example, he said a quarter of American workers were bound by restrictions that prevent them working for their employers’ competitors, limiting their ability to defect to rivals in search of higher wages.
“If employers collude to hold wages to a fixed, below-market rate, or if monopsony power increases over time, then wages could remain stubbornly resistant to upward pressure from increased labour demand in a booming economy,” Mr Krueger said.
Other economists focused on the rise of highly successful, technologically advanced “superstar” companies, which are conquering markets and leaving rank-and-file groups – and their workers – in their wake. Some argued that the growing heft of giants such as Amazon and Google was a result of their mastery of technology, and that this did not necessarily point towards uncompetitive conditions that were hurting consumers.
Others were less optimistic.
“All the good wages are in some firms and not in the rest,” said Raghuram Rajan, a professor at University of Chicago Booth School of Business and a former governor of the Reserve Bank of India. People in firms that are struggling are going to be asking the same question: “how come the elite are making away with everything?”
Stephen Poloz, the Bank of Canada governor, suggested that a more benign reason for muted price data may be that potential economic output is higher than central bankers believe, because of under-appreciated rates of technological change.
He cited research from Northwestern University that suggested digitalisation has led statistical agencies to underestimate investment, particularly in intangibles such as software and intellectual property.
“Central banks are working with estimates of potential output today that may be revised up in the future,” Mr Poloz said during a debate on Saturday. “Positive revisions to the history of potential output could help explain the underperformance of inflation over the past five years.”
Agustín Carstens, general manager of the Bank for International Settlements, said it was high time central bankers delved into these kinds of questions. “In a way, our minds were more on the combat of the global financial crisis and these things were put on the backburner,” he said.
Yet that does not make it obvious how central bankers should be responding.
Mr Krueger said one way of breaking the collusive corporate practices that were depressing workers’ pay was to allow the labour market to heat up further. But Robert Kaplan, the Dallas Fed president, argued against putting too much weight on low rates, when other policies such as better education and training would be needed to help workers adapt to the technological disruption of the jobs market.
“You have to be careful in trying to solve this problem [that] you don’t create other imbalances and heighten the cyclical pressures which would cause the Fed to fall back behind the curve and have to move more quickly,” he said. To do so “would in the medium term actually hurt employment and make this issue worse”.
Mr Poloz’s suggestion that technology may be boosting the economy’s capacity more rapidly than central bankers have believed, muting inflationary risks, echoes arguments by former Fed chairman Alan Greenspan in the 1990s. Yet the Fed was arguably too relaxed then, given the excesses that were brewing in markets.
“It is a very narrow path to get it right,” said Mr Carstens. “It is not easy to engineer this normalisation process and at the same time to preserve financial stability. The central banks will have to be very careful.”
– Copyright The Financial Times Limited 2018