Growth and Inflation Ahead of Jackson Hole

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The Jackson Hole Symposium is to focus on “fostering a dynamic global economy” which would seem to be an appropriate topic almost every year.   A decade ago, the Great Financial Crisis was emerging, and the world economy has come a long way.  

The early and aggressive action by US officials helped create the conditions by which the world’s largest economy recovered first to the point that the Fed could exit from its extraordinary measures and begin removing accommodation. It will soon take another “first step” by allowing its balance sheet to begin shrinking.   Most of the other major central banks lag behind the US by what appears to be quarters, not months.  The Bank of Canada is an exception.  It had eased policy with two rate cuts in the face the slide in oil prices, but began to remove this extra accommodation, and may take back the other hike in Q4.  

Two issues are frustrating central bankers.  Growth and inflation.   The challenge with the former increasingly appears to be seen as a function of poor productivity growth.  While central banks are concerned about the low productivity, addressing it seems to be outside the reach of monetary policy.  The US, UK, Germany, and Japan have seen strong employment gains, without a commensurate increase in output.

Some argue that productivity is being mismeasured.  The rise of the service sector may challenge traditional notions of productivity.  If a doctor sees a dozen patients in a day, is she really twice as productive as a doctor who seen six patient?  Would your favorite string quartet sound better with three?  The problem with this argument is that the same arguments could have been made before the crisis when the service sector was just as large.

There is also the possibility that the new technologies have yet to boost output.  Facebook, Airbnb, Twitter, and the explosion of apps, which can do provide rudimentary health diagnosis as well as monitor sleep patterns might not be about improving productivity.  In the work-life balance, maybe the technological advances are, at least at first blush, helping the latter not the former.

Some argue that weak productivity growth follows from the weak capital investment.  The argument is that if business invested more, productivity would grow faster and the speed limit of the economy would be raised.   Why aren’t businesses investing more?   Three broad reasons have been given for low capex.  First, aggregate demand can be met with existing capital stock.  Last week, for example, the US reported a capacity utilization rate of 76.7%.   Nearly every US business cycle has seen capacity utilization peak at a lower rate than the previous cycle.  Most recently, in the period before the Great Financial Crisis,  capacity utilization rose a little above 80%.  The previous cycle peak was a little below 85%.  Nearly three years ago, the cyclical peak was recorded a little below 79%.

Second, an argument put forward by Bain Capital is that businesses have not adjusted to the new era of lower cost capital.  They have an unrealistic threshold for the return on investment, their hurdle rate.  This is deterring the kind of investment that could boost productivity.  This is similar but different than the argument I presented in my new book, “Political Economy of Tomorrow”, where I focus on excess and redundant investment,and drawing from the work of  Harold Vatter, who anticipated Summer’s recent arguments by more than 30 years, that finds net private investment (net of depreciation) has been falling since the 1920s (in the US).

A third argument shifts the focus from private investment, which may not be needed, to public investment.   The lack of productivity growth is a function of the dearth of public investment.  A problem with this argument is that even in countries that have been committed to public investment do not appear immune to the slowdown in productivity.

The topic of the Jackson Hole gathering lends itself to a discussion of structural reforms and productivity, both of which Draghi and Yellen can wax eloquently.  The issue close to the heart of market participants is not the case of the missing productivity (and/or investment), but of the absent price pressures.

The Federal Reserve targets core inflation for specific reasons.  It is not as one pundit put it, of just excluding the undesirable components to prove whatever one wants.  To the contrary, the Fed focuses on core inflation because its research shows that it is a more reliable signal than headline inflation.  Specifically, headline inflation regresses to core inflation, and core inflation is thought to regress to wages.  Countries that have what the respective central banks think is near full employment are not seeing strong wage growth.

Since weak price pressures appear to be widespread, the most likely explanation is not on the idiosyncratic level of something unique to any one of the high income countries.   Most arguments focus on two common elements, demographics and technological advances.  the demographic challenge is most pronounced in Europe and Japan, and that is where the disinflationary forces are the greatest.  The median age of the world’s population has risen from 21 years to 30 years over the past four decades.  In high income countries, it the median age is pushing through 40 years.

The disruption caused by technological change is widely known.   It does not just spur a decline in the price of goods, but services as well.  Uber and Airbnb are the obvious examples, and they appear to deliver their services at cheaper costs than the traditional driving and hospitality services and require little new investment.  Although some herald this new “shared economy” but it is precisely because they are part of the market economy (not the sharing economy like within a household) that this type of technological change can minimize price pressures.

There is one institution whose reason for being is to improve the living standards of employees.  These are trade unions.  For numerous reasons, trade union membership has fallen.  In the US, about 6.5% of the private sector work force is unionized.    Many European countries have a higher rate of private-sector unionization, but it is decline nearly everywhere.     Ironically, in Germany, the SPD candidate for Chancellor is more critical of former SPD Schroeder’s Hartz labor reforms than Merkel who has embraced them.  In France, President Macron, the former Socialist economic minister, is trying to enact the kind of labor reforms his challenger Fillon (who was the self-styled French Thatcher) desired.

Lastly, just like it seems that trend growth has drifted lower over at least the past decade.  There are likely many contributing factors, but the demographic arguments seem the most persuasive.  Demographic forces do not appear to be sensitive to changes in monetary policy.  Just like growth may have entered a lower equilibrium phase, inflation may be doing the same thing.  There is nothing cast in stone about the 2% annual increase as the definition of price stability.  Part of the issue is deflation can be such a powerfully destructive force that officials want to have a little cushion above it, but what if it was 1.5% instead of 2%.?  Has the great moderation returned?