Christopher J Waller: What's the rush?
Speech by Mr Christopher J Waller, Member of the Board of Governors of the Federal
Reserve System, at the Finding Forward Speaker Series, University of St. Thomas,
Opus College of Business, Minneapolis, 22 February 2024.
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Thank you, Dean Dunham and the University of St. Thomas for the opportunity to speak
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to you today. Given that this event is co-sponsored by the Notre Dame Club of
Minnesota, and I taught at Notre Dame for 13 years, I will lead off with this thought: Go
Irish!
When I last spoke on January 16, the data we had received up to that point was very
good-three- and six-month measures of core personal consumption expenditures (PCE)
inflation were running right at 2 percent, which is our goal for total inflation, the labor
market was cooling but still healthy, and real gross domestic product (GDP) was
likewise growing but expected to moderate in the fourth quarter. I argued then that the
data was "almost as good as it gets." And I argued that because the economy was
doing so well, we could take our time and collect more data to ensure that inflation was
on a sustainable 2 percent path. There was no rush to cut rates any time soon.
Since then, we received data on fourth quarter GDP as well as January data on job
growth and consumer product index (CPI) inflation. All three reports came in hotter than
expected. GDP growth came in at 3.3 percent, well above forecasts. Jobs grew by
353,000, well over forecasts of less than 200,000, and monthly core CPI inflation came
in at 0.4 percent, which was much higher than it had been for the previous six months.
So, the data that we have received since my last speech has reinforced my view that
we need to verify that the progress on inflation we saw in the last half of 2023 will
continue and this means there is no rush to begin cutting interest rates to normalize
monetary policy.
Last week's report on consumer prices in January was a reminder that ongoing
progress on inflation is not assured. The uptick in inflation in that report was spread
widely among goods and services. This one month of data may have been driven by
some odd seasonal factors or outsized increases in housing costs, or it may be a signal
that inflation is stickier than we thought and will be harder to bring back down to our
target. We just don't know yet. While I believe inflation is likely on track to reach 2
percent in a sustainable manner, I am going to need to see more data to sort out
whether January's CPI inflation was more noise than signal. This means waiting longer
before I have enough confidence that beginning to cut rates will keep us on a path to 2
percent inflation.
Fortunately, the strength of output and employment growth means that there is no great
urgency in easing policy, which I still expect we will do this year. More data, and more
time, will tell whether January's CPI report was just a bump in the road to 2 percent
inflation. The hotter-than-expected data that we received validates the careful risk
management approach that Chair Powell has advocated in his recent public
appearances. And, with most data indicating solid economic fundamentals, the risk of
waiting a little longer to ease policy is lower than the risk of acting too soon and possibly
halting or reversing the progress we've made on inflation.
Let me start with the outlook for economic activity, including what we have learned from
the latest data. As I mentioned, real GDP grew strongly in the second half of 2023 and
that momentum has led forecasters to predict continued solid growth in the first months
of 2024. After expanding at a 4.9 percent pace in the third quarter last year and at a 3.3
percent clip in the fourth quarter, estimates for the first quarter of 2024 range from 1.7
percent for the Blue Chip average of private sector forecasters to 2.9 percent for the
Atlanta Fed's GDPNow model, which is based on the data in hand.
Among that recent data is the Institute for Supply Management's January survey of
purchasing managers. For non-manufacturing businesses, the index increased to a
level consistent with moderate growth. Meanwhile, the manufacturing index, while still
contractionary, rose to its highest level since October 2022, with rising orders and
production, continued improvement in delivery times, and inventory positions among
customers all pointing to favorable growth in demand.
While the balance of the evidence is that growth has continued at a moderate rate,
several indicators suggest some slowing. Retail sales fell 0.8 percent in January, after
rising 0.4 percent in December. While some of this drop is likely due to bad weather
and technical issues related to seasonal adjustment, it was a surprise. It may indicate
that consumer spending which ran higher than I expected in the second half of 2023 is
finally showing the effects of higher interest rates and a depletion of excess savings.
I will be watching to see whether spending stays robust. A positive sign is that
consumer confidence has continued to rise. One reason for that might be the labor
market, whose surprising strength continued in January. As I mentioned, the U.S.
economy created 353,000 jobs in January, and 333,000 in December, well above the
255,000 a month average in 2023 and also well above what most estimate to be
consistent with population growth. Job growth in January was widespread across
different sectors of the economy. There were job increases in three large sectors that
have faced sharp labor shortages: health care and social assistance, leisure and
hospitality, and state and local government. But there were also significant job
increases in parts of the economy that tend to rise and fall with changes in the pace of
economic activity-manufacturing, construction, retail trade and professional business
services. The gains in manufacturing and professional services were at or near the
highest posted in the previous 12 months.
Unemployment was steady at 3.7 percent, nearly as low as it has been in 50 years. And
while there were signs of slackening demand for labor over the course of 2023, those
signs haven't been so clear recently. The 12-month growth rate in average hourly
earnings fell from 4.7 percent in July to 4.3 percent in December and then rose to 4.5
percent in January. I have been focused on the number of job openings for the past two
years as an indicator of labor demand. Job openings fell from 12 million in April 2022 to
9 million in December 2023. We won't get data on job openings in January for a couple
of weeks, but openings unexpectedly ticked up in December, and the rate of people
quitting their jobs held steady, both indications that moderation in the labor market may
have stalled. One data point does not make a trend, and these strong job reports come
after a year of more or less steady loosening in the labor market, with supply increasing
relative to demand. But it does tend to support the idea of continued moderate growth in
economic activity. I will be looking for signs of continued loosening in the labor market,
which by most measures is still considerably tighter than it was before the pandemic.
Everything about the outlook that I have mentioned so far is important for what it tells us
about continued progress toward the Federal Open Market Committee's (FOMC) 2
percent inflation goal. Last week's high reading on CPI inflation may just be a bump in
the road, but it also may be a warning that the considerable progress on inflation over
the past year may be stalling. While 12-month CPI inflation improved a bit to 3.1
percent, it was higher than expected, as was the 3.9 percent rise in core inflation that
excludes volatile food and energy prices. Both the three-month and six-month changes
in core CPI increased in January. The FOMC's preferred inflation gauge, based on
personal consumption expenditures, isn't out yet for January, but an estimate factoring
in producer prices is that core PCE inflation rose to a 12-month rate of 2.8 percent, and
three- and six- month rates rose to 2.4 percent and 2.5 percent respectively.
While this uptick isn't a welcome development, let's take a deep breath and put it into
perspective. A year ago, core CPI inflation was 6.4 percent and core PCE inflation was
4.9 percent. Inflation has fallen by more than half since then, and the progress
continued all the way through December. Also, there was good news in the annual
seasonal adjustment factors this month to the past year of inflation data. In early 2023,
these revisions had revealed that inflation in 2022 was a lot worse than initial estimates,
and I was worried this would happen again this year. But the revisions on February 9
did not change the picture of a dramatic improvement in inflation in 2023. It is
comforting to know that the progress we made was real and not a mirage.
In judging whether January inflation was noise or a sign of slowing progress, one thing I
will be looking at are measures of wages and compensation. I mentioned the increase
in average hourly earnings last month. It is true that there was some moderation in
average wages over the second half of last year, but I still consider them to be
somewhat elevated to achieve our 2 percent goal. Other measures of compensation
show slow but continuing progress toward that target. The Bureau of Labor Statistics'
quarterly Employment Cost Index showed moderation in both salaries and bonuses in
the final three months of 2023. And the Atlanta Fed's Wage Growth Tracker continued
its very gradual decline in January. Payroll costs are the largest expense for most
businesses, and I will be watching to see whether wages and other compensation
continue to moderate or if they become a factor preventing progress toward our inflation
goal.
While I focus on the overall inflation numbers, it is still useful to look how the different
components of inflation have moved. A big factor in the improvement of inflation over
the past year has come from goods prices which fell during 2023. Goods prices
represent almost 25 percent of core CPI inflation. Even at times of very low inflation,
goods deflation is modest in a growing economy, so one question is whether this
contribution to progress on inflation will continue.
Another big contributor to CPI inflation is the cost of housing services, which measures
the estimated costs of renting or the equivalent for owning a home. Housing cost
inflation represents about 45 percent of core CPI inflation. There was a fairly steady
moderation in housing services inflation in 2023, as the slowing in market rent
increases since 2022 began to gradually show through to the housing services price
index. But we saw an unexpected jump in housing services inflation in the January CPI
data. I plan to be watching to see if housing costs continue to run at a higher rate than
expected.
The remaining component of core CPI inflation is services excluding housing. This
category is about 30 percent of the index. Inflation in this category moderated over the
course of 2023 but in January there was a broad-based increase. Since business
services are heavily reliant on labor input, this segment of prices is naturally
significantly influenced by labor compensation, such as wages and benefits. So, one
question is whether relatively elevated labor costs prevent moderation in this large
component of inflation.
As I consider all these aspects of inflation, I have to say that I see predominately upside
risks to my general expectation that inflation will continue to move toward the FOMC's 2
percent goal. On the flip side, I see little reason to expect that inflation will run below 2
percent for an extended period given the strong economic fundamentals we are
observing in GDP and employment. For these reasons, I am going to need to see a
couple more months of inflation data to be sure that January was a fluke and that we
are still on track to price stability.
This brings me to the implications of this outlook for monetary policy. Let me pause
here and say that typically the FOMC considers easing policy only when there are fairly
clear signs that the economy could be in or close to a recession. But, based on the
picture of the economy that I have painted today, it should be as clear to you as it is to
me that there are no indications of an imminent recession. By that I don't mean that the
picture of the economy is crystal clear. Sifting through the data, I see evidence of
ongoing robust growth in output and employment, but also some signs that growth may
be slowing. One thing that is clear is that by many metrics, the U.S. economy is healthy
and well positioned to continue growing and adding jobs. This is a good outcome, and
our job is not to stop it but rather to ensure that economic fundamentals grow in a
manner consistent with inflation at 2 percent.
That makes the decision to be patient on beginning to ease policy simpler than it might
be. I am going to need to see at least another couple more months of inflation data
before I can judge whether January was a speed bump or a pothole. I will be watching
wages and compensation, and the components of inflation that I outlined today to see
whether broad progress on inflation continues or stalls. I will also be monitoring
economic activity and employment, attentive as always to any unexpected warning
signs of a recession, but also paying close attention to whether growth in each is
consistent with continued progress toward 2 percent inflation.
I still expect it will be appropriate sometime this year to begin easing monetary policy,
but the start of policy easing and number of rate cuts will depend on the incoming data.
I likewise don't know whether the economy and employment will continue to barrel
ahead, or whether both will slow in a manner that I expect will support progress toward
2 percent inflation. But the upshot is that I believe the Committee can wait a little longer
to ease monetary policy.
Commentators often argue that by delaying rate cuts for a meeting or two we run the
risk of having overtight policy that can cause a recession in the near term. While I find
this narrative to be interesting, I also find it to be somewhat puzzling. The reason is as
follows. When rates are going up, most of the discussion is on the long and variable
lags of monetary policy with rate hikes not having a serious impact on the economy for
18 months or more. But when it comes to delaying rate cuts for a short period of time,
we supposedly risk suddenly driving the economy into a recession. This supposed
asymmetry in the lagged effects of rate hikes versus rate cuts is puzzling and not
supported by any economic model I am aware of.
How do we square the circle on this narrative? I think the explanation is that, as I noted
earlier, rate cuts tend to occur after major economic shocks that cause, or threaten to
cause, a recession. Historically, large and rapid rate cuts are highly correlated with
recessions, and this leads to the inference that policy was too tight and actually caused
a recession. But it is very difficult to untangle the effects of tight monetary policy from a
major economic shock when looking at past U.S. recessions. We do not have the
counterfactual of what impact delayed rate cuts would have had on the economy in the
absence of the economic shock. My conjecture is that, in the absence of a major
economic shock, delaying rate cuts by a few months should not have a substantial
impact on the real economy in the near term. And, I think I have shown that acting too
soon could squander our progress in inflation and risk considerable harm to the
economy.
In conclusion, the strength of the economy and the recent data we have received on
inflation mean it is appropriate to be patient, careful, methodical, deliberative - pick your
favorite synonym. Whatever word you pick, they all translate to one idea: What's the
rush?
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The views expressed here are my own and are not necessarily those of my
colleagues on the Federal Open Market Committee.