The Economic Outlook: Time to Let the Data Do the Talking
Remarks by
Christopher J. Waller
Member
Board of Governors of the Federal Reserve System
at the
17th Annual Vienna Macroeconomics Workshop (2022)
Vienna, Austria
September 9, 2022
Thank you, Klaus, and thank you for the invitation to speak at this workshop,
which I have been attending since its very beginning in 2004. Something that I love
about this conference that has kept me coming back almost every year is its tradition of
open inquiry and even some fun, on the one hand, combined with rigorous, critical
analysis, on the other. I am a supporter, and I guess a practitioner, of rigorous criticism,
because, as you may have heard, the conference award given each year for "outstanding
critic" was named for me. Based on the standard I set, the person who wins the award is
also known as the "most annoying participant." I suppose it was only karma that a guy
like me who likes to dish out the criticism would end up in a job that receives plenty of it.
Kidding aside, I do consider being the namesake for this award a great honor, and just to
make sure I don't get too much of a swelled head, by tradition the conference organizers
purposefully misspell my name.
My subject today is the outlook for the U.S. economy and the Federal Reserve's
ongoing campaign to bring down inflation and achieve our 2 percent objective.1 There
are three takeaways from my speech today. First, inflation is far too high, and it is too
soon to say whether inflation is moving meaningfully and persistently downward. The
Federal Open Market Committee (FOMC) is committed to undertake actions to bring
inflation back down to our 2 percent target. This is a fight we cannot, and will not, walk
away from. The second takeaway is that the fears of a recession starting in the first half
of this year have faded away and the robust U.S. labor market is giving us the flexibility
to be aggressive in our fight against inflation. For that reason, I support continued
increases in the FOMC's policy rate and, based on what I know today, I support a
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significant increase at our next meeting on September 20 and 21 to get the policy rate to a
setting that is clearly restricting demand. The final takeaway is that I believe forward
guidance is becoming less useful at this stage of the tightening cycle. Future decisions on
the size of additional rate increases and the destination for the policy rate in this cycle
should be solely determined by the incoming data and their implications for economic
activity, employment, and inflation.
Based on all of the data that we have received since the FOMC's last meeting, I
believe the policy decision at our next meeting will be straightforward. Because of the
strong labor market, right now there is no tradeoff between the Fed's employment and
inflation objectives, so we will continue to aggressively fight inflation. Inflation is
widespread, driven by strong demand that has only begun to moderate, by an ongoing lag
in labor force participation, and by supply chain problems that may be improving in some
areas but are still considerable. For these reasons, I expect it will take some time before
inflation moves back to our 2 percent goal, and that the FOMC will be tightening policy
into 2023. But the answers to questions of "how high?" and "for how long?" will depend
solely on incoming data.
Since I last spoke in July, I think the argument that we entered a recession in the
first half of 2022 has pretty much ended-we didn't. With each passing week, the
absence of any indication of a recession in spending or employment data buries that
recession argument a little deeper. We understand some of the factors that lowered the
gross domestic product (GDP) numbers in the first half, and a debate continues about
other possible factors, such as mismeasurement, potentially underreporting GDP. What
we can say is that after the Fed telegraphed its policy pivot to tightening in the latter
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months of 2021 and began raising rates in the first quarter of this year, demand and
economic activity slowed in the first half of 2022 from the strong pace of 2021. Data
suggest an uptick in consumption growth in the third quarter. Meanwhile, the Atlanta
Fed's GDPNow model forecasts real GDP will grow 2.6 percent this quarter, though
other estimates are a touch below this prediction.
Spending data are supportive of continued expansion. Nominal retail sales overall
were flat in July, but that is mainly because falling gasoline and auto prices-which is
good news-held back sales in those sectors. Excluding that, retail sales rose 0.7 percent,
suggesting that discretionary spending grew solidly. Businesses also continued to expand
production and spending. Total industrial production increased 0.6 percent in July,
standing 3.9 percent above its level a year ago. Forward-looking indicators of
manufacturing activity, such as new orders indexes in various manufacturing surveys, are
softer than earlier in the year, but most (and in particular the positive August reading
from the ISM) are not suggestive of a material pullback in manufacturing activity.
Meanwhile, the non- manufacturing ISM report suggests continuing growth, with its new
orders index rising to a solid level last month.
But there are signs of moderation in economic activity, which is what the FOMC
is trying to achieve by tightening monetary policy. Not surprisingly, higher interest rates
this year are slowing activity in the housing market. There have been declines in
construction of single-family homes for a number of months, with permits and home
starts both decreasing in July. Sales of existing and new single-family homes have also
slowed. Existing home sales fell by 5.9 percent to a seasonally adjusted annual rate of
4.8 million homes in July. While the imbalance between housing supply and demand
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remains significant, it has meaningfully improved. The inventory of unsold new and
existing homes has more than doubled since January. While the three months supply of
existing home is still below levels before the pandemic, the eleven months of new home
inventory is the highest since the spring of 2009. This latter statistic has raised concerns
by some about a significant downturn looming in the housing market, but an important
caveat is that much of the current elevated inventory reflects the recent low rate of
housing completion due to continued supply constraints. Many of these new homes for
sale are still under construction, and as supply constraints ease, builders will be able
deliver more completed homes to a market where the supply of existing homes remains
tight. All that said, the housing market is a significant channel for monetary policy, and I
will be watching this sector carefully.
The FOMC's goal is that the tightening in monetary policy slows aggregate
demand so that it is in better alignment with supply across all sectors of the economy.
My expectation is that strong household savings, the tight labor market, and additional
availability of manufactured goods as supply chains constraints continue to resolve will
allow households to make long-awaited purchases, which will provide a partial offset to
tighter policy. That will support a slowing, rather than a contraction, in demand.
Turning to the very strong labor market, private payroll employment has been
increasing at an average of nearly 400,000 a month over the last several months.
Unemployment rose two tenths of a percent in August to 3.7 percent, in part reflecting an
increase in the labor force participation rate, but still stands at a very low level. The
increase in participation was welcome news, but this rate is still far below that achieved
before the pandemic, when unemployment was roughly as low as today. We are facing
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worker shortages in many sectors of the economy. Job openings have started to decline a
bit but remain very elevated. These data confirm that the Fed is hitting its full
employment mandate, so all my attention is on bringing inflation down.
Inflation slowed in July, which was a very encouraging development. Headline
inflation for both the consumer price index and the index derived from personal
consumption expenditures (PCE)-the Fed's preferred measure-slowed, largely due to
continuing declines in prices for gasoline and other petroleum products. Excluding
volatile energy and food prices, core inflation for these two indexes also stepped down
from the rapid increases of earlier this year, but it is still too early to say that inflation is
moving meaningfully and persistently downward.
Inflation is still widespread. For both headline and core inflation, at least 60
percent of the underlying categories of different goods and services increased by 3
percent or more. Prices for housing services are elevated and still rising. Core goods
inflation continues to run well above its pre-pandemic level. Inflation for services
excluding housing has moved up this past year in part due to consumers shifting back to
more normal activities outside the household as social distancing has eased.
Looking ahead, I will be focusing on a number of factors that will influence
inflation. On housing services-rent and the so-called owners' equivalent rent -I expect
to see sizable increases in this component of inflation for a while as the recent rise in new
rentals makes its way into aggregate price measures.2 In a speech in March, I noted that,
based on various measures of asking rents, some analysts were predicting that the rate of
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rent inflation in the consumer price index could double in 2022, and so far it is on pace to
more than double.3 Owners-equivalent rent is similarly on pace to nearly double this
year.4 Sometime early next year, though, I expect to see the upward pressure on inflation
from these forces to ease as future increases in new or renewed leases moderate and the
full effects of monetary policy tightening make their way to housing services prices.
Beyond housing, I expect goods price inflation to continue to moderate as monetary
policy now and going forward slows the pace of increase in aggregate demand, supply
problems ease, and supply and demand come into better balance. There is some evidence
that goods supply production and delivery problems tied to the pandemic are improving,
with supplier delivery times and reports of items in short supply continuing to drop. In
terms of service price inflation, we saw a step-down in airfares and other travel-related
services last month, but I am uncertain about how these services, as well as food services,
and nonmarket services prices will evolve going forward.
Nominal wages have been growing quickly, and I'll be watching closely to see
how wage growth evolves and feeds into inflation. The Atlanta Fed's Wage Growth
Tracker hit another record in July for its 24 years of data, a 12-month rate of 6.7 percent
wage growth. I don't expect wage increases to ease up much unless and until there is a
significant softening in the labor market. One way to anticipate future wage growth is
through quit rates. Most people who quit their jobs are moving to others that pay
significantly better, so I take quits as one signal about where wages are headed in the near
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term. Quits are near their highest level over the 22 years that the government has tracked
them, but they have come down from the start of this year, and further decreases would
bring them closer to the level they were at immediately before the pandemic, when wages
were growing much more slowly than today.
Another factor that I will be watching closely is longer-term inflation
expectations, which I believe significantly influence inflation. As inflation moved higher
over the past year and a half, measures of short-term inflation expectations moved up
notably, but measures of longer-term expectations rose only a little and generally stand
near levels seen in the years before the pandemic, when inflation was low. In fact,
several measures of longer-term expectations have edged lower over the past couple of
months. To me, this means that the public retains confidence that the Fed will be able to
rein in inflation in the medium term.
To sum up, while I welcome promising news about inflation, I don't yet see
convincing evidence that it is moving meaningfully and persistently down along a
trajectory to reach our 2 percent target. I keep in mind that a year ago we saw similarly
promising evidence of inflation moderating for several months before it jumped up to a
high and then very high level. Those earlier inflation readings probably delayed our
pivot to tightening monetary policy by a few months. The consequences of being fooled
by a temporary softening in inflation could be even greater now if another misjudgment
damages the Fed's credibility. So, until I see a meaningful and persistent moderation of
the rise in core prices, I will support taking significant further steps to tighten monetary
policy.
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Now let me lay out the implications of this outlook for monetary policy. Since
March, the FOMC has raised our policy target range from near zero to between 21⁄4 and
21⁄2 percent. That puts the upper bound of the current target range at the median of
FOMC participants' longer-run projection for the policy rate, as recorded in the June
Summary of Economic Projections (SEP). This long-run rate is effectively where
participants think the policy rate would settle when the economy is growing at its
potential and inflation is at our 2 percent target. This is a good definition of success
when employment and inflation are near our goals and no help is needed from monetary
policy. But that isn't the case now; inflation is far from our goal, so more action is
needed. The policy rate will have to move meaningfully above this neutral level to
further restrain aggregate demand and put more downward pressure on prices.
Looking ahead to our next meeting, I support another significant increase in the
policy rate. But, looking further out, I can't tell you about the appropriate path of policy.
The peak range and how fast we will move there will depend on data we will receive
about the economy. Earlier this year, when we were ending asset purchases, inflation
was quite elevated, and we were lifting the target range off the effective lower bound, so
it made sense to provide forward guidance to help convey the urgency the FOMC felt
about tightening monetary policy. Forward guidance was useful in helping the public
understand how quickly we expected to tighten, and we saw longer-term interest rates
move up quite rapidly as a result of these communications. And additional hikes should
lead to further restraint in aggregate demand. As we continue to raise rates, we need to
see, month by month, how households and businesses are adjusting to the tighter
financial conditions, and how that adjustment is affecting inflation. We shouldn't be
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estimating what the peak level of the target range will be and how quickly we will get
there, because those details are much more dependent on what new economic data tell us
than was the case when the only direction for the federal funds rate to go was up-and up
by a lot.
This is not to suggest that I anticipate rate increases stopping very soon. I expect
that getting inflation to fall meaningfully and persistently toward our 2 percent target will
require increases in the target range for the federal funds rate until at least early next year.
But don't ask me about the policy path because I truly don't know-it will depend on the
data. Six months ago, I would not have thought that we would be where we are today,
with inflation so far from our target, after significantly tightening policy with a series of
large rate increases and by shrinking the balance sheet.
There are a range of possibilities for how the economy will perform, however,
and we can talk about the implications of that range. Say, for example, that inflation
follows the path laid out in the June SEP, which has core PCE inflation falling to 4.3
percent in the fourth quarter of 2022 and then moving toward 2 percent over 2023 and
2024. In that case, I would support our policy rate peaking near 4 percent. But based on
the experience of the past year and half, it would be foolish to express great confidence
that this plausible path will come to pass. Instead, it is important to consider the range of
possibilities and the appropriate policy responses. For example, if inflation does not
moderate or rises further this year, then, in my view, the policy rate will probably need to
move well above 4 percent. Alternatively, if inflation suddenly decelerates, then, in my
view, the policy rate might peak at less than 4 percent.
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One thing that is more predictable and has a significant effect on tightening policy
over time is the shrinking of the Fed's holdings of assets as maturing securities run off
our balance sheet. Starting this month, the Fed is shedding $60 billion a month in
Treasury securities and up to $35 billion a month in agency mortgage-backed securities.
This action effectively increases the supply of securities in the hands of private investors
and will thus put upward pressure on interest rates, as private investors must now be
enticed to hold these assets.
All told, the FOMC has taken unprecedented and decisive policy actions this year
to quickly increase the policy rate in response to high inflation. But where we stand now
is not good enough. Though the labor market is strong, inflation is too elevated. So I
support another significant hike in two weeks. After that, the tightening path will
continue until we see clear and convincing evidence that inflation is moving
meaningfully and persistently down to our 2 percent target. The pace of tightening is
uncertain; it will depend on the data. No matter what, I am ready and willing to do what
it takes to bring inflation down.