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Comments from Former Fed Chief Janet Yellen at ISM Meeting 2019

I had an opportunity to speak at ISM this week on a presentation related to our just released CAPS study on combating counterfeiting.  At the main session Tuesday morning, I also got to hear Tom Linton’s speech as he accepted the Shipman Award, and also got to spend some time with him afterwards discussing our next book…. too early to let you know what it’s going to cover!  But it will be exciting..

I also had the opportunity to listen to Tom Derry interview Janet Yellen, the former Fed Chief, on her thoughts relative to the current economic picture.  Ms. Yellen’s comments reflected many of the obervations we’ve discovered through our workshops this semester on labor challenges in the logistics sector, as well as the incredible growth of the economy.  I was also somewhat disappointed to hear her thoughts on procurement, which consisted primarily of viewing the contribution to cost reduction as the only real value of procurement.  This was a sign in my mind of how disconnected the Fed is from what procurement and supply managers are able to achieve in the field, or else perhaps just a function of the poor communication we offer to the public!  At any rate, here is what Ms. Yellen had to say about the economic situation we find ourselves in today.

Labor force participation is flat, and the participation rates are going up.  They plummeted during the great recession during the financial crisis, with a weak economy. Many people searched actively enough, many became discouraged, and didn’t search actively enough. As the labor market strengthened, they have come back into the labor force. But prime age labor force participation has risen over and above that fact.  As we try to drive down costs to find low-cost labor in supply chains, this relates to this.  There is downward pressue on the wage of less-skilled Americans, and some of this may be due to global competition.  The 50th percentile and below – there has been no gain in real adjusted wages since the 1980s.  The top 10% and top 1% have done well – but the gap between college and high school has gone up – if you have a high school education or less, your wage have done almost nothing in the last twenty years.

The more important issue is technological change, and robotics – which has boosted the demand for skilled labor, and led to offshoring and a reduced need for less skilled labor.  This has resulted in a loss of job that can be offshored, and the downward pressure on wages.  Since the late 90s, the real wages have been going down for men, and this seems to most economists that this has nthing to do with the Great Recession.  This is a longer-run issue that reflects globalization and social impacts.  In these communities where we see a decline in male and female participation rates, a stagnation in incomes, and a breakdown of communities and social life, and for white Americans, increase in mortality rates due to deaths of despair  – opioids, suicide and alcohol.

Recently it has been surprising to see how much labor force participation is going up – as economists thought these long term trends are continuing, and are intensifying.   The deep downturn caused a plunge, but we expected it to continue.  The unemployment would be even lower as it is drawing people who dropped out of the labor force- they are coming back in again!  You expect in a tight labor market to see inflation grow.  It has moved back to 3%, and we are seeing some upward pressure, and there are a lot of vacancies, and not a lot of workers.  Seeing more quits, people who feel good about job prospects quitting rather than holding on to their jobs.  They come back to you

Firms are not experiencing productivity issues, and are not experiencing the types of pressures on their margins that would drive inflation.  Two worries these days are that inflation could rise above desirable levels, and the second is that inflation could be too low.  In a tight labor market – if growth continues to pressure it – inflation could move above levels of 2%.   So they may want to raise interest rates a bit in this case.  But if inflation is too low, that’s different.  For about 7 years now inflation running under 2%.  It has dipped a little bit below 2%, and one of the most important drivers is the expectations the businesses have of price increases that other firms will be establishing in the form of wage increases, and end up determining what inflation is.

Historically in the US, short-term interest rates averaged above 4%.  They have been coming down in all developed countries, and it looks like a phenomenon that pre-dates the financial crisis.. Estimates place the real short-term rates under 1% – with a 2% of average inflation, means interest rates are 3%, which is very low. In the typical post-war downturn, the Fed has cut interest rates by 5 full percentage points – if the normal level is 3%, the Fed doesn’t have that scope.  Japan has had 0% for years, and Germany has had low interest rates with no increases in store.  You have to worry that with another downturn, the US has a bit more scope to respond.

And 2-2.5%  is very low.  But if fiscal policy isn’t there to generate demand then what are the options? Inflation in the Great Depression was at 2%, and the Fed did everything they could to keep to 0, bought $3.5 trillion of long-term assets, but still inflation was below 2% for seven years.  Here we have inflation at 2% with tightest labor market in 50 years – but eventually there will be a recession, and there isn’t a lot of ammunition to address a downturn!  But if they don’t have ammunition – will be less than 2%…could this lead to a Japan-like situation.  We have an inverse yield curve – and people see short rates sitting where they are – and further increases are unlikely – and short rates may be less, that could be one factor which results in an inverted yield curve.

If you had a major increase in oil prices that caused a period of high inflation – and once oil stabilized, inflation should come back down.  If inflation expectations are well-anchored, that will happen – but if they aren’t, inflation expectations can ratchet up – and this can create high inflation.

If you look at most US inflation expansions – what caused them to end?  More often it is the Federal Reserve brought about a recession for price stability and full employment – and if inflation goes up, they drive up monetary policy to bring inflation down, which can then cause a recession.  More stable inflation makes it less likely.  2% is NOT a recession in the US – but US economies potential growth rate, without putting more pressure on the labor market – how fast can it grow with a labor market where unemployment is 3.8 – the answer is only 1.9.  If productivity growth was faster – we could sustain faster growth but it suggests we can’t.  Growth can only be no more than 2.0!

If I were in my old job I’d be really happy!  We have a president who wants to see growth like a rocket ship and hopes his tax plan will do that – but we haven’t seen that productivity growth.  We have the tightest and best labor market we’ve ever seen, an economy at full employment and growth slowing to a sustainable pace which is consistent with trends, so I think we should leave inflation where it is at.