How I Spent My Summer Vacation
September 8, 2014 --
For those of you who spent at least some of August enjoying sun, sand, and other such holiday fun: welcome back. In many northern countries, with the turn of seasons younger students often shake off summer cobwebs by composing that timeless welcome-back-to-school essay, “How I Spent My Summer Vacation.”
Many of the world’s leading central bankers spent summer vacation in summer school trying to figure out what policies to pursue in the new year. The most important class session was the Federal Reserve Bank of Kansas City Annual Symposium in lovely Jackson Hole, Wyoming. The invited symposium papers by leading academics puzzled about the health—or lack thereof—in labor markets.
Steve Davis and John Haltiwanger, two of the world’s experts on labor-market dynamics, wrote about the unfortunate reality that “U.S. labor markets became much less fluid in recent decades.” They concluded that “sustained high employment is unlikely to return without restoring labor-market fluidity”—a policy challenge so far removed from anything Washington leaders are talking about as they return from their five-week (yes, five-week) summer recess that it would be laughable were it not so serious. Wages expert David Autor offered insightful reasons to hope that technology innovation will not destroy more jobs than it creates. Yet he also acknowledged that the twin forces of innovation and globalization are typically not good for everyone, and that the adjustment to these forces “is frequently slow, costly, and disruptive.”
What did the central bankers take away from such uplifting lessons? We worry that the main reaction may have been, “Hmm, this year’s assignment will be even harder than I thought. Can I get extra time or help with this?”
In her Jackson Hole speech, Federal Reserve Chairwoman Janet Yellen discussed the many mixed indicators in today’s U.S. labor market. Best of all is the new composite metric Fed colleagues have crafted from 19 distinct data series, the Labor Market Conditions Index, to try to clarify the miasma of, for example, being close to full employment at 6.1 percent (as of Friday’s latest Employment Situation report) yet seeing no upward pressure in real wages for so many workers amidst continued low labor-force participation.
The basic assignment facing Chairwoman Yellen is likely to be raising U.S. interest rates—and how to communicate to the world how, when, and why this is happening. “What’s a monetary policymaker to do?” she asked in her Jackson Hole remarks, perhaps as a head start angling for generous grading of her looming communications assignment. Market-based and individual forecasts widely point to higher U.S. interest rates sometime in 2015. Will these expectations prove accurate?
In his Jackson Hole speech, European Central Bank President Mario Draghi talked about the still-looming economic threats to the 18-country euro zone, including unemployment still at 11.5 percent and growth in gross domestic product over the past 12 months of just 0.7 percent. He also talked about the costs potentially being larger for policymakers doing too little, not too much, if conditions worsen. On cue, days later the EU’s statistical office announced that in August euro-zone consumer prices rose at a year-over-year rate of just 0.3 percent: down from 0.4 percent in July, far lower than the ECB’s target of 2.0 percent, and the lowest rate since the depths of the Great Recession five years ago. Beneath this scary euro-zone disinflation lurks outright deflation in countries now including Spain and even Mr. Draghi’s home of Italy, for the first time there since 1959 when he was just 12 years old.
The basic assignment facing President Draghi in the new school year is avoiding deflation. At his disposal is the size and asset composition of the ECB’s balance sheet. His marks will depend on what he does with this balance sheet and on how these actions move inflation, jobs, and output. Keen to earn high marks at least for prompt and earnest effort, last Thursday Mr. Draghi surprised the world by announcing three changes: a cut to the ECB main refinancing rate (from 0.15 percent to a nearly imperceptible 0.05 percent); a cut to the rate it pays banks for deposits they place at ECB (from negative 0.1 percent—yes, negative, as we earlier discussed here—to negative 0.2 percent); and a plan to expand the ECB balance sheet by buying hundreds of billions of euros of private-sector—not government—bonds.
The broader student body watching these new central-bank assignments is, well, all of us. What will happen to jobs, inflation, interest rates, equity prices, and other key economic and financial indicators? Ah, the joy of a new school year: colorful fall leaves, sharp new pencils, and a raft of intricate global financial questions. Class is again in session. Enjoy.
Articles © 2014 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2014 Trustees of Dartmouth College. All rights reserved.