Economic Letter
Brief summaries of SF Fed economic research that explain in reader-friendly terms what our work means for the people we serve.
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Can Monetary Policy Tame Rent Inflation?
Zheng Liu and Mollie Pepper
Rent inflation has surged since early 2021. Because the cost of housing is an important component of total U.S. consumer spending, high rent inflation has contributed to elevated levels of overall inflation. Evidence suggests that, as monetary policy tightening cools housing markets, it can also reduce rent inflation, although this tends to adjust relatively slowly. A policy tightening equivalent to a 1 percentage point increase in the federal funds rate could reduce rent inflation as much as 3.2 percentage points over 2½ years.
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Financial Market Conditions during Monetary Tightening
Simon H. Kwan and Louis Liu
The current round of federal funds rate increases is expected to reverse a historically large gap between the real funds rate and the neutral rate at the beginning of the tightening cycle. Financial markets have reacted faster and more strongly than in past monetary tightening cycles, in part because of this large gap and the Federal Reserve’s forward guidance. Historical experiences suggest financial conditions could tighten even more given the size of the gap.
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Supply Chain Disruptions, Trade Costs, and Labor Markets
Andrés Rodríguez-Clare, Mauricio Ulate, and Jose P. Vasquez
Global supply chain disruptions due to the COVID-19 pandemic have increased the costs of trade between countries. Given the interconnectedness of the U.S. economy with the rest of the world, higher trade costs can have important impacts on U.S. labor markets. A model of the U.S. economy that incorporates variation in industry concentrations across regions can help quantify these effects. The analysis suggests that recent global supply disruptions could cause a sizable and persistent reduction in labor force participation.
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Are Inflation Expectations Well Anchored in Mexico?
Remy Beauregard, Jens H.E. Christensen, Eric Fischer, and Simon Zhu
Price inflation has increased sharply since early 2021 in many countries, including Mexico. If sustained, high inflation in Mexico could raise questions about the ability of its central bank to bring inflation down to its 3% inflation target. However, analyzing the difference between market prices of nominal and inflation-indexed government bonds suggests investors’ long-term inflation expectations in Mexico are close to the central bank’s inflation target and are projected to remain so in coming years.
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Recession Prediction on the Clock
Thomas M. Mertens
The jobless unemployment rate is a reliable predictor of recessions, almost always showing a turning point shortly before recessions but not at other times. Its success in predicting recessions is on par with the better-known slope of the yield curve but at a shorter horizon. Hence, it performs better for predicting recessions in the near term. Currently, this data and related series analyzed using the same method are not signaling that a recession is imminent, although that may change in coming months.
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When the Fed Raises Rates, Are Banks Less Profitable?
Pascal Paul
Banks limit their interest rate risk exposure by issuing adjustable-rate loans and protect their funding costs by slowly adjusting deposit rates. These actions allow banks to maintain largely stable profit margins even if monetary policy tightens unexpectedly. Evidence from the pre-pandemic tightening cycle suggests that bank profit margins could increase rather than decline over the coming months. However, the slow adjustment of rates that banks pay on deposits may result in people moving their savings, leading to a reallocation of assets away from the regulated banking system.
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Oil Shocks when Interest Rates Are at the Zero Lower Bound
Wataru Miyamoto, Thuy Lan Nguyen, and Dmitry Sergeyev
New evidence suggests that rising oil prices associated with declining oil supply slow economic activities less when interest rates are constrained at the zero lower bound. Moreover, these oil price spikes can even increase overall output. Evidence points to the following explanation. An oil supply shock raises inflation in all periods, but the nominal interest rate does not react under the zero lower bound, so the shock reduces the real interest rate, stimulating demand in the economy.
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Resolute and Mindful: The Path to Price Stability
Mary C. Daly
As monetary policymakers work to deliver low and stable prices and an economy that works for all, they will need to be resolute and mindful. This means moving firmly toward our goal, while constantly calibrating our stance of policy so that we go far enough to get the job done, but not so far that we overdo it. The following is adapted from remarks by the president of the Federal Reserve Bank of San Francisco to the Orange County Business Council in Irvine, California, on November 21.
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Passing Along Housing Wealth from Parents to Children
Matteo Benetton, Marianna Kudlyak, Louis Liu, John Mondragon, and Mitchell Ochse
Young adults are more likely to own a home if their parents are homeowners than if their parents are renters. New research reveals how parents owning a home can lead to an increase in the persistence in homeownership across generations. Specifically, homeowner parents are often able to extract the equity value from their home to help their children purchase a home. This “dynastic” home equity enables children of homeowner parents who extract equity to accumulate approximately one third more housing wealth by age 30 than children of renters.
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Can the News Drive Inflation Expectations?
Augustus Kmetz, Adam H. Shapiro, and Daniel J. Wilson
How households expect inflation to evolve plays an important role in explaining overall inflation dynamics. Household expectations rose dramatically over the past year or so, much faster than professional forecasters’ inflation expectations. News coverage can explain part of this growing gap. Analyzing the volume and sentiment of daily news articles on inflation suggests that one-fourth of the increased gap between household and professional expectations can be attributed to heightened negative media coverage. These results highlight the important impact of the content and tone of economic information on the real economy.