For release on delivery
12:40 p.m. EST
November 29, 2016
Recent Economic Developments and Longer-Run Challenges
Remarks by
Jerome H. Powell
Member
Board of Governors of the Federal Reserve System
at
The Economic Club of Indiana
Indianapolis, Indiana
November 29, 2016
Thank you for the opportunity to speak here today. My plan is to discuss the U.S.
economy from three different perspectives. I will start by taking stock of the current
expansion--a business cycle point of view. Then I will shift the focus to some of the
longer-term challenges we face in coming years. I will conclude with a discussion of
monetary policy. As always, the views I express here today are mine alone.
The Current State of the Economy
As you know, the Congress has tasked the Federal Reserve with achieving stable
prices and maximum employment--the dual mandate. Today, we are not far from
achieving those goals.
The Federal Open Market Committee (FOMC) has an objective of 2 percent for
inflation, as measured by the annual change in the price index for personal consumption
expenditures. The Committee sees this objective as symmetrical, so that minor
deviations above or below 2 percent are treated alike.1 Inflation has consistently run
below 2 percent since 2011, and is now at 1.2 percent over the past 12 months (figure 1).
This headline measure of inflation has recently been held down by falling energy and
food prices. We also monitor core inflation, which excludes the volatile energy and food
components because they often send a misleading signal about underlying inflation
pressures. Core inflation is running at 1.7 percent over the past 12 months. Both
measures have gradually moved upward toward 2 percent.
U.S. inflation trended steadily lower after the Volcker disinflation of 1981 to 1982
and has been low and reasonably stable for many years. In fact, for the past several years
inflation has run below policy targets in many parts of the world, including here in the
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United States. Many of us are old enough to remember when the only challenge was to
keep inflation low. But too-low inflation can also be a serious problem. Below-target
inflation increases the real value of debts owed by households and businesses and reduces
the ability of central banks to respond to downturns.
The public's expectations about inflation are thought to be an important driver of
actual inflation. Many measures of U.S. inflation expectations--both from surveys and
from market-based readings--are still well below their pre-crisis levels, although some
have moved up as of late. The only way to ensure that inflation expectations remain
safely anchored near the FOMC's target is to keep inflation close to that target on a
consistent basis. So, while the current shortfall may seem small, it is important that
inflation continue to move up to 2 percent, as I expect it will.
The FOMC does not have a numerical goal for maximum employment because
the long-run sustainable level of employment changes over time and is determined
mainly by nonmonetary factors that are outside the Fed's control, such as evolving labor
market practices, demographics, social change, and fiscal and regulatory policies.
Nonetheless, four times each year FOMC participants write down their estimates of the
longer-run normal level of the unemployment rate (the natural rate); at the September
FOMC meeting the median estimate was 4.8 percent, very close to the current
unemployment rate of 4.9 percent.
Other labor market measures are also healthy, including payroll job creation and
labor force participation. Employers have been adding roughly 180,000 jobs per month
so far this year--a pace a little below that of the past several years but significantly higher
than underlying growth in the labor force (figure 2). Despite these strong job gains, the
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unemployment rate has flattened out this year after several years of sharp declines, thanks
to welcome developments in labor force participation (figure 3).
The labor force participation rate represents the percentage of adults aged 16 and
over who are in the labor force, which is defined to include only those who are employed
or actively looking for work. When people enter or reenter the labor force and begin to
search for a job, that is generally a good thing even though at the margin their entry tends
to increase the unemployment rate (or prevent it from declining). Beginning in the
1960s, labor force participation rose steadily as women entered the paid workforce
(figure 4). That trend ran its course as participation peaked around 2000 and has declined
steadily since then as a result of the aging of our population and other longer-run trends,
notably the decline in participation by men in the heart of their working-age years. Going
forward, many analysts expect labor force participation to decline at a trend rate of
roughly 0.3 percent per year as a result of these factors. However, participation fell much
more sharply than that after the financial crisis. Some of those who left the labor force
went back to school, but others moved onto disability, took early retirement, or just
became discouraged and stopped seeking work. The sharp drop raised fears that the
crisis might leave behind permanent damage to our labor force. Fortunately, since late
2013, the participation rate has remained about flat and thus has gradually moved back
close to its estimated longer-term trend.2 On net, people have been entering and
remaining in the labor market as job prospects have brightened, offsetting the natural
decline from population aging.
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Surveys of households and firms also suggest that we are near full employment
(figure 5). For example, respondents are now more likely to say that jobs are plentiful
than that they are hard to get--a response that has generally been seen when the economy
is near full employment. Job vacancies are running at high levels, and firms report that it
is getting harder to find employees to fill open positions. Moreover, wages are now
rising faster than inflation, and faster than output per hour. Taken together, labor market
indicators show an economy that is on solid footing and close to our mandate of
maximum employment.
It is interesting to compare this expansion to past U.S. expansions, and also to
recoveries of other countries since the end of the Global Financial Crisis. The picture is a
mixed one. The current recovery has been under way since June 2009--nearly seven and
a half years. It will soon be the third longest of the 20 recoveries since the founding of
the Federal Reserve in 1913. GDP, or output, is now 11 percent higher than its pre-crisis
peak. Employment is now 6.5 million higher than its pre-crisis peak.
But this expansion has also had the slowest pace of GDP growth of any postwar
recovery (figure 6). Given steady but modest growth, we have seen surprisingly large
gains in employment and, until this year, a rapid reduction in the unemployment rate.
Even though GDP growth has been slow, job gains during this recovery have been
stronger than those during the previous expansion--the so-called jobless recovery of the
early 2000s. The combination of weak growth and strong hiring in this expansion
implies small increases in output per hour, or productivity. In fact, productivity has been
increasing at a dismal pace, compared with virtually any period in the postwar era. I will
return to productivity and growth in a moment.
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More positively, our current recovery compares fairly well with those of other
advanced economies (figure 7). Output has increased faster, and unemployment has
declined faster, in the United States than in other major advanced economies. And the
Fed's challenges in getting inflation back up to 2 percent are similar to, but not as severe
as, those faced by some other major monetary authorities.
Turning to the near-term outlook, after a slow patch in the first half of this year,
growth has clearly strengthened. I expect that the economy will continue on its path of
the last few years, with real GDP growth of about 2 percent, strong job gains, a tightening
labor market, and inflation moving up toward our 2 percent objective. The main risks I
see to that outlook are from abroad. Growth and inflation are low around the world.
With interest rates so low, we are not well positioned to respond to negative shocks,
whatever the source.
Longer-Run Challenges
Productivity and Growth
Let's turn to longer-run challenges, and start by asking why growth has been so
slow, and how fast we are likely to grow going forward. This next slide shows the five-
year trailing average annual real GDP growth rate (figure 8). By this measure, growth
averaged about 3.2 percent annually through the 1970s, the 1980s, and the 1990s. But
growth began to decline after 2000 and then nose-dived with the onset of the Global
Financial Crisis in 2007 and the slow expansion that followed. Since the financial crisis
ended in 2009, forecasters have gradually reduced their estimates of long-run trend
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growth from about 3 percent to about 2 percent--a seemingly small difference that would
make a huge difference in living standards over time.3
How much of this decline is just a particularly bad business cycle, and how much
represents a long-run downshift? To get at that question, let's take a deeper look at the
growth slowdown. We can think of economic growth as coming from two sources: more
hours worked (labor supply) or higher output per hour (productivity). Hours worked
mainly depends on growth in the labor force, which has been slowing since the mid-
2000s as the baby-boom generation ages. As you can see, the labor force is now growing
at only about 0.5 percent per year (figure 9). Another way to see this is through the
sustained increase in the ratio of people over 65 to those who are in their prime working
years (figure 10). This long-expected demographic fact has now arrived, and it has
challenging implications for our potential growth and also for our fiscal policy.4
The unexpected part of the growth slowdown reflects weak productivity growth
rather than lower labor supply. Labor productivity has increased only 1/2 percent per
year since 2010--the smallest five-year rate of increase since World War II and about
one-fourth of the average postwar rate (figure 11). The slowdown in productivity has
been worldwide and is evident even in countries that were little affected by the crisis
(figure 12). Given the global nature of the phenomenon, it is unlikely that U.S.-specific
factors are mainly responsible.
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A portion of the productivity slowdown is undoubtedly due to low levels of
investment by businesses. The financial crisis and the Great Recession left firms with
excess capacity, reducing incentives to invest. If businesses expect slower growth to
continue, that will also hold down investment.
The other important factor is the decline in what economists call total factor
productivity, or TFP, which is the part of productivity that is not explained by capital
investment or increases in the skills of the labor force. TFP is thought to be mainly a
function of technological innovation and efficiency gains.
There is no consensus about the future direction of productivity.5 The pessimists
argue that the big paradigm-changing innovations, such as electrification or the advent of
computers, are behind us. If that is so, then our standard of living will increase more
slowly going forward. The optimists think that this slowdown is only a passing phase
and that the age of robots and machine learning will transform our economy in coming
decades. Still others argue that we are currently underestimating productivity and output
because of the real difficulties we face in measuring GDP in a modern economy. For
example, how do we measure the value-added of free digital services like Facebook or
Twitter?6
The future is, as always, uncertain. But I would sum up the growth discussion as
follows. Growth in the labor force has slowed, and we can estimate it with reasonable
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confidence to be only about 0.5 percent. Growth in productivity is both more important
and much harder to predict. Productivity varies significantly over time, as figure 11
showed. If productivity growth returns to, say, 1.5 percent, then the U.S. economy could
grow at about 2.0 percent over the long term. Actual growth may turn out to be weaker
or stronger, and the choices we make as a society will have something to say about that.
Why Are Long-Term Interest Rates So Low?
Let's turn to the related question of why long-term interest rates are so
extraordinarily low in advanced economies around the world. The yield on our own
benchmark 10-year U.S. Treasury security has increased lately, but at 2.3 percent it is still
far below what was normal before the financial crisis. In fact, this next chart shows that,
as growth and inflation have fallen, longer term interest rates have fallen as well over the
past 35 years (figure 13).
So why are long-term interest rates so low? Many of you will no doubt be
thinking, "They are low because you people at the Fed set them low!" While there is an
element of truth there, that is not the whole story. The FOMC has considerable control
over short-term interest rates. We have much less influence over long-term rates, which
are set in the marketplace. Long-term interest rates represent the price that balances the
supply of saving by lenders and demand for funds by borrowers, such as businesses
needing to fund their capital expenditures. Lenders expect to receive a real return and to
be compensated for inflation and for the risk of nonpayment. Meanwhile, borrowers
adjust their demand for funds based on their changing assessment of the risks and
expected returns of their investment projects. When desired saving rises or investment
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demand falls, then long-term interest rates will decline. Today's very low level of long-
term rates suggests that both of these factors are at play.
Both expectations of slower growth and the aging of our population are having
significant effects on desired saving and investment and are thus important causes of
lower interest rates. If the economy is expanding more slowly, then the level of
investment needed to meet demand will be lower. The lower path of growth reduces
future income prospects of households, and they will tend to raise their saving. The
pending retirement of baby boomers means higher saving, because people tend to save
the most in the years just before their retirement. In addition, the lower rate of return on
capital owing to lower productivity growth will lead to less investment and lower interest
rates.
As with productivity, the factors behind the fall in U.S. interest rates include an
important global component, as rates are low around the world. Indeed, although our
rates are near historical lows, U.S. Treasury rates are among the highest among the major
advanced economy sovereigns (figure 14).
Is This the New Normal?
What can we do to prevent low growth, low inflation, and low interest rates from
becoming the new normal? We need to focus on ways to increase our long-term growth
and spread that prosperity as broadly as possible. I hasten to add that these policies are,
for the most part, outside the purview of the Federal Reserve. We need policies that
support productivity growth, business hiring and investment, labor force participation,
and the development of skills. We need effective fiscal and regulatory policies that
inspire public confidence. Increased spending on public infrastructure may raise private-
sector productivity over time, particularly with the growth of the stock of public
infrastructure near an all-time low.7 Greater support for public and private research and
development, and policies that improve product and labor market dynamism may also be
fruitful.8 Monetary policy can contribute by supporting a strong and durable expansion
in a context of price stability.
Monetary Policy
The low interest rate environment presents special challenges for monetary
policy. In setting our target for the federal funds rate, a good place to start is to identify
the rate that would prevail if the economy were at 2 percent inflation and full
employment--the so-called neutral rate. "Neutral" in this context means that the rate is
neither contractionary nor expansionary. If the fed funds rate is lower than the neutral
rate, then policy is stimulative or accommodative, which will tend to raise growth and
inflation. If the fed funds rate is higher than the neutral rate, then policy is tight and will
tend to slow growth and reduce inflation.
But we can only estimate the neutral rate, and those estimates are subject to
substantial uncertainty. Before the crisis, the long-run neutral rate was generally thought
to be roughly stable at around 4.25 percent. Since the crisis, estimates have steadily
7
See, for example, Abdul Abiad, Davide Furceri, and Petia Topalova (2014), "IMF Survey: The Time Is
Right for an Infrastructure Push," World Economic Outlook (Washington: International Monetary Fund,
October), www.imf.org/en/News/Articles/2015/09/28/04/53/sores093014a.
8
See, for example, International Monetary Fund (2016), "Acting Now, Acting Together," Fiscal Monitor
(Washington: IMF, April), www.imf.org/external/pubs/ft/fm/2016/01/fmindex.htm; Ryan A. Decker, John
Haltiwanger, Ron S. Jarmin, and Javier Miranda (2016), "Declining Business Dynamism: What We Know
and the Way Forward," American Economic Review, vol. 106 (May), pp. 203-07,
www.aeaweb.org/articles?id=10.1257/aer.p20161050; Steven Davis and John Haltiwanger (2014), "Labor
Market Fluidity and Economic Performance," NBER Working Paper Series 20479 (Cambridge, Mass:
National Bureau of Economic Research, September); The Department of the Treasury Office of Economic
Policy, the Council of Economic Advisers, and the Department of Labor (2015), "Occupational Licensing:
A Framework for Policymakers" (Washington: The White House, July),
www.whitehouse.gov/sites/default/files/docs/licensing_report_final_nonembargo.pdf.
declined, and the median estimate by FOMC participants stood at 2.9 percent in
September. Many analysts believe that the neutral rate is even lower than that today and
will only return to its long-run value over time.9 The low level of the neutral interest rate
has several important implications. First, today's low rates are not as stimulative as they
seem--consider that, despite historically low rates, inflation has run consistently below
target and housing construction remains far below pre-crisis levels. Second, with rates so
low, central banks are not well positioned to counteract a renewed bout of weakness.
Third, persistently low interest rates can raise financial stability concerns. A long period
of very low interest rates could lead to excessive risk-taking and, over time, to
unsustainably high asset prices and credit growth. These are risks that we monitor
carefully. Higher growth would increase the neutral rate and help address these issues.
Turning to the outlook for monetary policy, incoming data show an economy that
is growing at a healthy pace, with solid payroll job gains and inflation gradually moving
up to 2 percent. In my view, the case for an increase in the federal funds rate has clearly
strengthened since our previous meeting earlier this month. Of course, the path of rates
will depend on the path of the economy. With inflation below target, relatively slow
growth, and some slack remaining in the economy, the Committee has been patient about
raising rates. That patience has paid dividends. But moving too slowly could eventually
mean that the Committee would have to tighten policy abruptly to avoid overshooting our
goals.
Conclusion
To wrap up, since the end of the Great Recession in 2009, our economy has
recovered slowly but steadily. Today, we are reasonably close to achieving full
employment and our 2 percent inflation objective. But we face real challenges over the
medium and longer terms. Our aging population will mean slower growth, all else held
equal. If living standards are to continue to rise, we need policies that will support
productivity and allow our dynamic economy to generate widespread gains in prosperity.
Recent Economic Developments and Longer-Term
Challenges
Jerome Powell
Member
Board of Governors of the Federal Reserve System
November 29, 2016
1. Inflation is moving up toward target
Percent change from
12 months earlier
12
10
8
Core Total
6
4
2
0
-2
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
- - - - - - - - - - - - - - - - - - -
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
2. Payroll employment growth is solid
Millions
Thousands
Average 3-month change*
125 40
400
Private (left)
200
Government (right)
120 35
0
115 30
-200
-400
110 25
-600
-800
105 20
an an an an an an an an an an
3. Unemployment has returned to pre-crisis levels
Percent
12
10
8
6
4
2
0
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
- - - - - - - - - - - - - - - - - - - - - - - -
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
4. Labor force participation rate has stabilized
Percent
Percent
90
68
80
67
Total
66
70
65
60
64
50
Female
63
Male
40
62
Total
61
5. Household and business surveys indicate a healthy job market
Index
Index
NFIB-Jobs Hard to Fill
Jobs Plentiful
60
60
40
50
20
40
30
0
20
-20
10
-40
0
-60
Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr Apr
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
- - - - - - - - - - - -
- - - - - - - - - - - - -
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
6. The expansion in context of the past
Percent change Percentage point
Unemployment Rate
Real GDP
from trough change from trough
160
2.0
1970
1.0
150
1960
0.0
2002
1982
140
-1.0
1975
1991
1991
-2.0
1954
130
1958
1949 -3.0
1975
1960
120
2002
-4.0
1970
2009
1949
1954
2009
1958 -5.0
110
1982
-6.0
1 5 9 13 17 21 25 29 33 37
100
1 5 9 13 17 21 25 29 33 37 Quarters from trough
Quarters from trough
7. The expansion in international context
Percent change
Percentage point
from trough
change from trough
120
5
Unemployment Rate
Real GDP
4
115
3
U.S.
Euro area
2
U.K.
110
1
U.K.
0
Japan
105
-1
Japan
Euro area
-2
U.S.
100
-3
-4
95
-5
2009 2011 2013 2015 2009 2011 2013 2015
8. GDP growth has slowed over time
Percent change
5
Decade average
5-year average
4
3
2
1
0
9. Labor force has slowed
Percent change
4
Decade average
5-year average
3
2
1
0
10. The population is aging
Ratio of those aged 65 and over to
working-age population
0.45
0.40
0.35
0.30
0.25
2016
0.20
0.15
0.10
0.05
0.00
11. Labor productivity growth is low
Percent, 5-year average
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1970:Q1 1973:Q1 1976:Q1 1979:Q1 1982:Q1 1985:Q1 1988:Q1 1991:Q1 1994:Q1 1997:Q1 2000:Q1 2003:Q1 2006:Q1 2009:Q1 2012:Q1 2015:Q1
12. Productivity slowdown is global
6
GDP per hour worked in OECD countries (growth rates, percent)
5
4
3
2
1
0
-1
-2
-3
1995-2004 2005-14 Difference
↑
-4
Italy
Chile
Israel Spain
Japan
Korea
States
Turkey France
Poland
Greece Ireland
Finland Iceland Mexico
Canada
Norway Sweden Zealand
Belgium
Hungary Portugal
Republic
Kingdom Australia
Denmark
Germany
Switzerland
Netherlands
Luxembourg
New
United
Czech
United
13. U.S. interest rates are very low
Percent
20
18
16
14
10-year Treasury
12
Federal Funds
10
8
6
4
Nov.
2
0
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
- - - - - - - - - - - - - - - - - - - - - - - -
14. Sovereign rates are low around the world
Percent
10-year Sovereign Yields
10
U.K.
U.S.
Nov.
Germany
Japan
9876543210
-1
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
- - - - - - - - - - -