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The Star-ry Night in Jackson Hole
Central bankers will soon travel to Jackson Hole, Wyoming, as they do every year, to think big thoughts on monetary policy and relax under the stars.
Each year Fed officials and invited guests—often other foreign central bankers and academics—gather in Jackson Hole to listen to (and give) speeches, learn about new research, and spend time chatting informally in a very scenic place.
The topic this year is “Structural Shifts in the Global Economy.” During economic tumult and higher inflation and interest rates in most countries, the discussions, instead, will look out years ahead and discuss whether this is the new normal. If not, where are we headed? These questions are even more unanswerable now than usual, but it’s worthwhile to consider the possibilities and what to look for.
Here are my two cents on Bloomberg on Jackson Hole:
What will Jay say?
Powell will strive to be as boring as humanly possible in his speech. He will repeat, some of it word for word, what he said at the last FOMC meeting or last FOMC minutes—which are released three weeks after every meeting. Markets will move anyway. It was a sentence in the FOMC minutes last week to finally convince everyone in markets that there will be no cuts this year, and Fed may still go higher and likely stay high for a good while. The Fed’s been saying that for a while and has been ignored. Then it’s the minutes? Communication policy is wild.
There’s a good reason not to get creative. Powell, as Chair, speaks for the FOMC, not himself. There are two major data releases—employment and CPI inflation—before the next vote in September. Why box the FOMC in when you don’t have to? His speech will be short; we will learn nothing from him if all goes well.
If not Jay, who will be the star?
The letter R.
Central bankers—trying to figure out how much they need to do to get inflation down—will get something of a break; this year, the Jackson Hole conference is about the structural or long-term changes in the economy. What’s beneath all the mess? And what’s on the other side? Do we go back to before, or is this the new normal? Or is there something else?
The math- and jargon-laden research at the event matters for everyone, not just the Fed. For example, will mortgage rates stay high for several years? Or will we get back to the pre-pandemic low rates? The ‘why’ is important, but the ‘what’ will drive people’s decisions.
Almost certainly, a topic of discussion will be the neutral (natural) rate of interest or R-star. It is the federal funds rate at which the Fed is doing nothing; it doesn’t have to because growth is at its best, inflation is at 2%, and we have maximum employment.It’s the Nirvana rate. Rates above it will slow the economy and below will slow it. The Fed is trying to get the federal funds rate above the neutral rate and get inflation down.
There’s one catch: we can’t see R-star. We back it out from the economy. John Williams is, one of the preeminent scholars on R-star and President of the New York Fed. See his recent speech on it.
A shooting star
All this can get pretty wonky fast, so let’s focus on one crucial factor that moves R-star: productivity. It’s the Holy Grail of prosperity. Do you think in five or ten years, we will be making more stuff with fewer people (an increase in productivity) or making less (a decline in productivity)? If productivity growth goes up, trend growth goes up, so there’s more to buy, more income, and more reasons to invest. R-star goes up. If productivity goes down, trend growth, and R-star does too.
So, where is productivity headed? Productivity growth has slowed over the past twenty years after being strong in the 1990s. Growth has been around 2%, but it was 5% back then, and inflation was low then too.
One can make a case for higher productivity: Work-from-home (maybe) and artificial intelligence are recent developments that could make us more productive. They have helped me do my work, but I still need to be convinced about how widespread and large the effects will be. And those effects would need to be sizeable to turn around the low productivity growth.
Conversely, some factors could lower productivity. One example, we have a dire present and future for the climate. Severe weather events this year, including the floods in California, fires in Maui, and heatwaves across the country, reduce productivity. My Bloomberg Opinion piece today discusses how high heat already reduces labor productivity. (Twitter thread too.)
Declines in labor productivity are the primary channel through which higher temperatures affect the economy. Researchers with the Atlantic Council, a moderate think tank, estimated in 2021 that they cost the US economy $100 billion annually by reducing labor productivity, or around 0.3% of gross domestic product. If businesses and the economy don’t adapt, the reduction in productivity could reach 0.5% of GDP by 2030 and 1% by 2050. That’s just one of several estimates, but the adverse effects of rising temperature on productivity is a common conclusion.
Jackson Hole will be jam-packed with discussions about monetary policy. It’s unfortunate that everything is framed in terms of the Fed, especially when the theme is structural features of the economy. The Fed has minimal effect on those. Fiscal policymakers should have a Jackson Hole. They affect the structural.
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The public isn’t invited to Jackson Hole, except for Chair Powell’s speech, which is live-streamed. But with rooms starting at $350 a night, the people in “hardship” from high inflation—who the Fed tells us they worry about—wouldn’t be able to make it anyways. Also, it seems interest rates are not high enough for the Fed to reduce their demand and switch to a cheaper venue.
I was asked about the 2% inflation target and if the Fed might raise it to 3% to avoid higher interest rates for longer, which raise the risk of a recession. Set aside the credibility issues—not doing what they promised. Telling the American people the Fed’s new goal is higher inflation would cause an uproar. More likely, if inflation gets stuck somewhat above, the Fed might just round and call 2.3 a 2.0.
It is doubtful that R-star now and R-star in the long run are the same. Too many supply-side disruptions and imbalances remain from the pandemic. Powell made it clear that estimates of R-star are a tool but not something that policy hinges on. See this great piece on the natural rate from Nick Timiraos in the Wall Street Journal.