Restoring Price Stability in an Uncertain Economic Environment
Remarks by
Lael Brainard
Vice Chair
Board of Governors of the Federal Reserve System
at
"Shocks and Aftershocks: Finding Balance in an Unstable World"
64th National Association for Business Economics Annual Meeting
Chicago, Illinois
October 10, 2022
It is a pleasure to join this discussion today.1 Inflation is high in the United States
and around the world reflecting the lingering imbalance between robust demand and
constrained supply caused by the pandemic and Russia's war against Ukraine. Global
supply chains have eased significantly, but by some measures they are still more
constrained than at nearly any time since the late 1990s.2 High inflation places a burden
on all Americans, but especially lower-income families, who spend three-fourths of their
income on necessities-more than twice the share spent by higher-income families. The
Federal Reserve has tightened policy strongly to bring inflation down, and U.S.
tightening is being amplified by concurrent foreign tightening. We are starting to see the
effects in some areas, but it will take some time for the cumulative tightening to transmit
throughout the economy and to bring inflation down. Uncertainty remains high, and I am
paying close attention to the evolution of the outlook as well as global risks.
Higher interest rates are working to temper demand and bring it into better
alignment with supply, which is still constrained. Output has decelerated so far this year
by more than anticipated, suggesting that policy tightening is having some effect. Real
gross domestic product (GDP) declined at an annual rate of roughly 1 percent in the first
half. Real private domestic final purchases stepped down from a 6.4 percent pace last
year to an annual rate of only 1.3 percent during the first half of this year.
Recent revisions to national income and product accounts data imply that the
current stock of excess savings held by households is lower and has been drawn down
- 2 -
more rapidly in recent quarters than had been previously estimated. Indeed, by Board
staff estimates, the revisions imply that the stock of excess savings held by households is
about 25 percent lower, which may imply a more subdued pace of consumer spending
going forward than had been projected.
Market expectations for the level of the policy rate at the end of the year are now
more than twice as high as they were just seven months ago. As a result of the significant
increase in interest rates and associated tightening in broader financial conditions, I now
expect that the second-half rebound will be limited, and that real GDP growth will be
essentially flat this year.3
The moderation in demand due to monetary policy tightening is only partly
realized so far. The transmission of tighter policy is most evident in highly interest-
sensitive sectors like housing, where mortgage rates have more than doubled year to date
and house price appreciation has fallen sharply over recent months and is on track to soon
be flat. In other sectors, lags in transmission mean that policy actions to date will have
their full effect on activity in coming quarters, and the effect on price setting may take
longer. The moderation in demand should be reinforced by the concurrent rapid global
tightening of monetary policy.
Against the backdrop of slower output growth, we are seeing some tentative signs
of rebalancing in the labor market. Anecdotal reports suggest the availability and
- 3 -
retention of workers are improving.4 For the second month in a row, growth in monthly
payroll employment stepped down, slowing from 315,0000 in August to 263,000 in
September. There was a sharp 1.1 million decline in job openings from July to August in
the Job Openings and Labor Turnover Survey (JOLTS). The ratio of job openings to job
seekers declined to 1.7; for purposes of comparison, this ratio was 1.2 prior to the
pandemic.5 The sharp fall in vacancies at a time when initial claims held steady at low
levels provides support for the possibility that businesses that faced significant challenges
finding and retaining qualified workers following the pandemic may be more inclined
than in past cycles to retain rather than lay off their workers as demand weakens. In
particular, there is still a sizable 1.2 million shortfall in employment levels relative to pre-
pandemic levels in the in-person services sectors that accounted for the majority of
September payroll gains, suggesting businesses in those sectors may still be trying to
narrow that gap.6
That said, a variety of indicators suggest labor demand remains strong, while
labor supply remains below pre-pandemic conditions. The unemployment rate is now at
the very low level that prevailed pre-pandemic, and the volume of quits remains
4
For example, the discussion in the September Beige Book notes that "overall labor market conditions
remained tight, although nearly all Districts highlighted some improvement in labor availability,
particularly among manufacturing, construction, and financial services contacts. Moreover, employers
noted improved worker retention, on balance." See Board of Governors of the Federal Reserve System
(2022), Beige Book (Washington: Board of Governors, September 7),
https://www.federalreserve.gov/monetarypolicy/beigebook202209.htm.
5
The current ratio is calculated as the number of job openings at the end of August in the most recent
JOLTS release, divided by the number of unemployed persons reported in the September 2022 Current
Population Survey.
6
The total shortfall in the level of employment in September 2022 relative to the level in February 2020
from the retail trade, educational services, local government education, health care and social assistance,
and leisure and hospitality sectors was 1.16 million.
- 4 -
elevated.7 This supply-demand imbalance in the labor market is reflected in strong wage
growth. The employment cost index increased by an annual rate of 6.3 percent over the
second quarter-its highest level in decades. A more-timely data source, average hourly
earnings, decelerated slightly to a 4.4 percent annual rate over the third quarter, down
from 4.6 percent annual growth in the second quarter. Although it is well above levels
consistent with 2 percent inflation, wage growth has been running below current
inflation.
Strong wage growth along with high rental and housing costs mean that inflation
from core services is expected to ease only slowly from currently elevated levels. In
contrast, core goods have been expected to return to something closer to the pre-
pandemic trend of modest disinflation as a result of demand rotation away from goods to
services, coupled with the healing of supply chains and declining core import prices.
Disinflation in core goods would help to offset the inflationary pressures in services.
During the five years before the crisis, core goods made a small negative contribution to
inflation. The contribution of core goods to inflation swung sharply into positive territory
in 2021, and had started to step down somewhat in the middle part of 2022.8 So the
surprise in the August inflation data was the large contribution of core goods inflation to
overall inflation at a point in the post-pandemic recovery when many forecasts
anticipated this contribution would continue moderating.
- 5 -
Since the pandemic, significant supply and demand imbalances have coincided
with large increases in retail trade margins in several sectors. In some sectors, the
increase in the retail trade margin exceeds the contemporaneous increase in wages paid to
the workers engaged in retail trade, although this is not true in food and apparel. The
return of retail margins to more normal levels could meaningfully help reduce
inflationary pressures in some consumer goods, considering that gross retail margins are
about 30 percent of total sales dollars overall.
For instance, among general merchandise retailers, where the real inventory-to-
sales ratio is 20 percent above its pre-pandemic level, retail margins have increased 20
percent since the onset of the pandemic, roughly double the 9 percent increase in average
hourly earnings by employees in that sector.9 In the auto sector, where the real
inventory-to-sales ratio is 20 percent below its pre-pandemic level, the retail margin for
motor vehicles sold at dealerships has increased by more than 180 percent since February
2020, 10 times the rise in average hourly earnings within that sector.10 So there is ample
room for margin recompression to help reduce goods inflation as demand cools, supply
constraints ease, and inventories increase.
Despite the higher prices for a broad set of goods and services, market- and
survey-based measures of longer-term inflation expectations are within ranges consistent
with expectations that inflation will return to 2 percent over the medium term.11 Treasury
- 6 -
Inflation-Protected Securities-based measures of five-year, five-year-forward breakeven
inflation compensation are currently at 2.15 percent, roughly 10 basis points below their
level at the start of the year. The median of inflation expectations over the next 5 to 10
years in the Michigan survey ticked down in September to 2.7 percent, below the 2.9 to
3.1 percent range in which it had been fluctuating since July 2021 and back within the
range that was common before the 2015 decline in this metric.12 Currently, there is a
greater dispersion than usual of views about future inflation in survey responses.
Previously this reflected a rise in expectations for significantly above-target inflation, but
now that dispersion also reflects expectations on the part of one quarter of respondents
that prices are likely be the same or below their current level 5 to 10 years in the future.
In order to bring inflation down and to keep inflation expectations solidly
anchored at 2 percent, the Federal Reserve has increased the federal funds rate target
range by 300 basis points in the past seven months, and both market and policymaker
surveys indicate additional increases through the end of this year and into next year. In
addition, balance sheet shrinkage is now proceeding at its maximum rate, reinforcing the
move to a restrictive stance. Broader U.S. financial conditions have tightened rapidly in
response: The two-year Treasury yield has moved above 4 percent for the first time since
2007, and the 10-year yield is near its highest level in over a decade at 3.9 percent.
Corporate bond yields have risen even more, as investment- and speculative-grade
corporate bond spreads have increased about 80 basis points and 170 basis points,
- 7 -
respectively, over the year. Mortgage rates have more than doubled since the beginning
of the year. The Board's broad dollar index has appreciated 11 percent year to date.13
Monetary policy tightening is also proceeding rapidly abroad. Many central
banks in large economies have raised rates by 125 basis points or more in the past six
months, and yields on 10-year sovereign debt in Canada, the United Kingdom, and the
largest euro area economies have seen increases on the order of 190 to 360 basis points
this year.14
The combined effect of concurrent global tightening is larger than the sum of its
parts. The Federal Reserve takes into account the spillovers of higher interest rates, a
stronger dollar, and weaker demand from foreign economies into the United States, as
well as in the reverse direction. We are attentive to the risk of further adverse shocks-
for instance, from Russia's war against Ukraine, the pandemic, or China's zero-COVID
policies. And we are also very aware that the cross-border effects of unexpected
movements in interest rates and exchange rates, as well as worsening external
imbalances, in some cases could interact with financial vulnerabilities. In this
environment, a sharp decrease in risk sentiment or other risk event that may be difficult to
anticipate could be amplified, especially given fragile liquidity in core financial markets.
In some countries, the realization of these risks could pose challenging tradeoffs for
policy.
- 8 -
That said, the real yield curve is now in solidly positive territory at all but the very
shortest maturities, and the entire real curve will soon move into positive territory with
the additional tightening and deceleration in inflation that are expected over coming
quarters. Monetary policy will be restrictive for some time to ensure that inflation moves
back to target over time. It will take time for the cumulative effect of tighter monetary
policy to work through the economy broadly and to bring inflation down. In light of
elevated global economic and financial uncertainty, moving forward deliberately and in a
data-dependent manner will enable us to learn how economic activity, employment, and
inflation are adjusting to cumulative tightening in order to inform our assessments of the
path of the policy rate.