With New Year’s Eve right around the corner, here’s a countdown of our own to close out 2019. Check out the five most popular FRBSF Economic Letter topics of the year with research insights from San Francisco Fed economists.
5. WAGE GROWTH
The unemployment rate ended 2018 at just under 4%. Could such an ostensibly tight labor market lead to a sharp pickup in wage growth from its recent moderate pace? Investigations using state-level data show no economically significant nonlinearity between wage growth and unemployment that would predict an abrupt jump in wage growth.
4. THE FED’S BALANCE SHEET
The Fed’s balance sheet is significantly larger since before the financial crisis of 2008-2009, partly because of the rising demand for currency. The balance sheet will also need to remain large because the Federal Reserve now implements monetary policy in a regime of ample reserves, using a different set of tools than in the past to achieve its interest rate target.
A hot economy eventually boosts inflation. Such is the simple wisdom of the Phillips curve. Yet inflation across developed countries has been remarkably weak since the 2008 global financial crisis, even though unemployment rates are near historical lows. What is behind this recent disconnect between inflation and unemployment?
Imports from China are an important part of overall U.S. imports. Tariffs implemented thus far may have contributed an estimated 0.1 percentage point to consumer price inflation and 0.4 percentage point to price inflation for business investment goods. Estimates suggest an across-the-board 25% tariff would raise consumer prices and investment prices an additional 0.3 percentage point and 1.0 percentage point, respectively.
The Phillips curve describes inflation as a persistent process that depends on public expectations of future inflation and economic slack. The role of each component has changed over time: maintaining the public’s expectations that the Fed is committed to an inflation target has grown in importance. Such considerations are important as the Federal Reserve evaluates its future policy options.
2. NEGATIVE INTEREST RATES
After Japan announced a negative policy interest rate in 2016, market expectations for inflation over the medium term fell. The reaction stresses uncertainty surrounding negative policy rate effectiveness as expansionary tools when inflation expectations are anchored at low levels. Japan’s experience also illustrates desirability of taking preemptive steps to avoid the zero interest rate bound.
The Fed dropped the federal funds rate to near zero during the Great Recession to bolster the U.S. economy, which may have reduced the depth of the recession and enabled the economy to return more quickly to its full potential. It also may have allowed inflation to rise faster toward the 2% target. In other words, negative interest rates may be a useful tool to promote the Fed’s dual mandate.
Given the low level of interest rates in many developed economies, negative interest rates could become an important policy tool. Because of this, it’s important to carefully examine evidence from economies whose central banks have already deployed such policies. Research suggests that negative rates may be an effective monetary policy tool to help ease financial conditions.
Efforts to adapt to climate change and limit its associated risks will have increasingly important effects on the U.S. economy. These are relevant considerations for the Federal Reserve in fulfilling its mandate for macroeconomic and financial stability.
The Federal Reserve Bank of San Francisco recently hosted a conference on the economics of climate change to gather and debate the latest analyses from universities and policy institutions, nationally and abroad. It was the first Fed-sponsored conference devoted to investigating the economic and financial consequences and risks arising from climate change and potential policy responses.
FRBSF Economic Letter returns on January 6 with all-new research insights. We know you have a lot going on this time of year, so join the email list and we’ll let you know when it posts.
Happy New Year!
The views expressed here do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.