The U.S. Economy and the Curious Case of Missing Demand
Speaking before the Joint Economic Committee in May, Federal Reserve Chair Ben Bernanke delivered a somewhat ominous diagnosis of the U.S. economy. Couched within boilerplate language detailing the “moderate pace” of economic growth, Bernanke said that — alongside the usual benefits of lower interest rates (which, in turn, support increased spending) — the Fed’s exceptionally accommodative monetary policy “has also helped to offset incipient deflationary pressures and kept inflation from falling even further below the Committee’s 2 percent longer-run objective.”
At the time, consumer price inflation was up 1.4 percent on the year. One-month trimmed mean personal consumption expenditures — a measure that the Fed prefers to consumer price index inflation — were increasing at an annual rate of 1.5 percent, while six-month trimmed mean PCE inflation was climbing at an annual rate of 1.1 percent.
In a word, inflationary pressures over the past two years have been soft. The deflationary pressures that Bernanke warned about in May have only manifested in negative price growth occasionally, and mostly deeper in the pipeline or in import and export prices. Soft but positive inflation is something to keep an eye on but nothing to write home about. In fact, many market participants have cheered soft inflation. As long as inflation expectations remain anchored near the 2 percent longer-term objective (and unemployment remains high, as it has), then the Fed will continue its market-boosting stimulus program.
Over the past two years, price pressures in the United States have been modest but have not struggled too hard to remain positive. On Wednesday, though, the U.S. Bureau of Labor Statistics reported that the consumer price index for all urban consumers (CPI-U) contracted to a seasonally adjusted 0.1 percent in October. This was the first contraction of the headline inflation index in six months and it took economists, who were expecting the index to flatline, by surprise.
The report doesn’t necessarily change the tone of the conversation surrounding inflation, but it may help draw attention to an economic concern that has sometimes been overlooked. Sen. Bob Menendez (D-N.J.) raised the issue at a recent Senate hearing regarding the nomination of Janet Yellen to succeed Bernanke as Fed chair.
“Some critics have argued that any growth that results might somehow be artificial,” he said, “or that low interest rates and cheaper credit may lead to financial instability or asset bubbles as investors make riskier investments in order to quote, ‘reach for the yield.’ In the current environment, though, my question is isn’t weak demand the greater concern?”
He continued: “I look at consumers pulling back from their spending because of high debt burdens, underwater mortgages from the financial crises, businesses holding off on investing because of weak consumer demand — doesn’t that change the relative costs, benefits, and risks of different monetary policy actions?”
Menendez was touching on a subject that is generally reserved for conservative-leaning critics: Does the Fed actually have a cure for what ails the economy? Chair of the Joint Economic Committee Kevin Brady (R-Texas) asked Bernanke the same question but with regards to unemployment in May.
Yellen, though, responded as though she had prepared for the question.
“Well, senator, I completely agree that weak demand for the goods and services that this economy is capable of producing is a major drag holding back the economy,” she said. “And, of course, the purpose of our policies — all of them — are to bring down interest rates in order to spur spending in interest-sensitive sectors. If we’re capable of doing that, that will help to stimulate a favorable dynamic in which jobs are created, incomes rise, more spending takes place, and that creates more jobs throughout the economy. So I agree with your diagnosis, and our programs are intended to remedy the situation of weak demand.”
But evidence of that favorable dynamic is hard to find. Job growth is still underwhelming, incomes have pretty much been flat, and surveys conducted by Gallup show that consumers are planning to trim their holiday spending this year.