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By HaleStewart April 10, 2016 7:57 am
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US Bond Market Week in Review: A Look At Evans' and Rosengren's Speeches

     Last week saw the release of the latest Federal Reserve Meeting Minutes.  Various news services and pundits have already (and sufficiently) parsed that document.  But in addition to the minute’s release, several Fed Presidents gave speeches.  Below I will focus on parts of Fed President Rosengren’s and Chicago President Evan’s comments as they offer insight each president’s current economic thinking.              

Fed President Rosengren’s Speech

     Fed President Rosengren’s speech contained the following two paragraphs:

It is important to remember that these market probabilities [regarding the pace of interest rate hikes] can change significantly, and rapidly. When weaker economic data are released, the probability of tightening built into futures markets falls; conversely, when stronger data are released, the probability of tightening is seen as increasing. Figure 3 shows that over the past two months, the probabilities have shifted significantly. The probability assigned to seeing no change in the federal funds rate this year was less than 30 percent two months ago, rose to over 50 percent one month ago, and most recently has returned to 38 percent.

One reason for these changing probabilities has been the weak economic data, particularly from abroad. Figure 4 shows that European and Japanese stock markets weakened significantly in the middle of February, and still remained well below their levels in the middle of December. Figure 5 shows that the declines in U.S. stock markets were more modest, and have now rebounded to levels prevailing in mid-December of last year.

Because it takes 12-18 months for a change in interest rates to completely move through the economy, analysts assume the Fed ignores short duration market events like those that occurred in the first quarter.  Previous Fed statements have supported this perspective.  However, Rosengren’s comments highlight an important fact: markets are excellent “real-time” sentiment measures, with prices representing the sum-total of all publicly available data.  Price increases represent bullish sentiment while price declines show bearishness.  Extreme volatility like that which occurred in the first quarter represents severe confusion.  Rosengren's statements certainly agrees with that analysis.

President Evans Speech

     Fed President Evan’s speech contained three cautionary notes about future growth, beginning with this demographic observation:

One important productive resource is labor. Here, demographics are working against us. The U.S. Census Bureau projects that the population aged 16 and over will grow a little less than 1 percent per year over the next ten years; by comparison, between 1990 and 2010 the average annual growth of the adult population was 1.2 percent. Moreover, our population is graying, and consequently, fewer of us will be working. Over the next ten years, the share of the population that is 65 or older is expected to increase about 4 percentage points from 15 to 19 percent. Since about 2000, this aging of the population and other long-running trends have been bringing down the fraction of the population participating in the labor force. My staff’s estimates suggest that these structural factors will reduce the growth of available workers by about a quarter of a percentage point per year over the next ten years or so. Slower growth in available workers translates into less potential output growth.

Starting in the early 2000s, researchers began to analyze the impact of aging baby boomers on economic growth.  Their general conclusion was we’d potentially see lower growth, barring meaningful policy action.  Japan has already offered us a glimpse of this demographic development, and the results aren’t pretty: they lead to slower growth and an economy bordering on deflation.  For more on this topic, search The Big Picture blog for the term “labor force participation rate.”

     My staff also estimates that between 1980 and 2000, higher educational attainment and increases in workforce experience added more than half a percentage point a year to labor quality — that is to say, the effective labor input into the aggregate production function for the U.S. grew a half a percentage point a year faster than the increase in total number of hours worked.[3] However, further progress seems to have stalled as new entrants to the labor force have roughly similar educational attainment as retiring baby boomers, but less work experience. This is another possible reason for slower potential economic growth.[4] 

This is fascinating observation.  The baby boomers were much better educated than the preceding generation.  And, over the last 30 years, they have accumulated a tremendous amount of practical business knowledge, which now leaves the labor force as they retire.  Evan’s statement implies that, although the new generation has knowledge, it hasn’t matured.  Combined with the drain of experience, the labor force has lost enough intellectual capital to be a drag on growth.

     And finally, Evans’ notes:

Economic growth over the longer run also depends upon technological progress. By one carefully estimated measure — made by John Fernald at the San Francisco Fed and his co-authors — the underlying trend in total factor productivity (TFP) growth has declined from 1.8 percent during the productivity boom of the mid-1990s to the mid-2000s to a mere half a percent today.[5] That is in line with the period of low productivity growth from the 1970s to the mid-1990s. Some economists, such as Robert Gordon (2012) at Northwestern, think that the slowdown in trend productivity growth possibly is here to stay. Gordon argues that the search for transformative technologies that spurred productivity and economic growth in the past has become increasingly costly and more difficult to harvest: We have already picked the low-hanging fruit. The gloomy conclusion of his line of reasoning is that slow productivity growth will hold back potential economic growth for the foreseeable future.

Not everyone subscribes to the view that TFP growth will inevitably slow because of the dearth of new inventions. Rapid advances in the field of medicine and in energy production are two examples of where we have seen huge productivity improvements. Furthermore, it takes time for innovations to work their way into productive technologies. It may be that transformative innovations are being created today, but have yet to make their way through the pipeline to show up as measurable increases in factor productivity.

I’m very much a “Johnny-come-lately” to this argument, so I have little to add.  However, by my recollection, the last big technological change was the micro-chip and computers.  Fed President Greenspan noted their impact during a speech in the mid-1990s, when he noted there was “something” he couldn’t concretely identify underlying growth.  But since then, we really haven’t had the “next big thing” in technology.  As Evan’s notes, that does not mean we couldn’t potentially see it tomorrow.  But, as of yet, it isn’t there.

     While Yellen understandably gets a larger percentage of the press coverage, don't forget to read and listen to the other Fed governors.  Each also has a wealth of economic knowledge that infuses each public presentation.  

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