Despite the large and growing deflationary pressures, Federal Reserve Chair Janet Yellen stuck to the central bank’s party line in her speech to the National Association for Business Economists in Cleveland on Sept. 26. She argued that the weaker inflation is transitory.
Yes, she admitted, the Fed’s 2 percent target for personal consumption expenditures inflation, the central bank’s favorite measure, has been continually undershot, but “the restraint imposed in recent years by a variety of special factors, including movements in the relative prices of food, energy and imports, will wane in coming quarters.”
There are two problems with that statement. First, she’s been saying this for some time, but those “special factors” — items such as falling mobile-phone service costs, lower airfares, weak oil prices in 2014 through 2016, and declines in education and health care costs — just keep coming. After a while, continual “special factors” become a deflationary trend, which is fundamentally the result of a world in which supplies of productive capacity and labor exceed demand in most areas.
Second, Yellen, like most forecasters, thinks conditions move to a nice, steady long-run equilibrium. In this case, the Fed sees that nirvana as 2 percent annual inflation, 1.8 percent real gross domestic product growth, a 4.6 percent unemployment rate and a 2.9 percent federal funds rate. But steady states don’t exist for long, and long-run equilibria are simply crossing points through which the economy and financial markets move on their way to high and low extremes. Forecasts of long-run steady states are no more than hyper-quantifications of ignorance.
Real GDP grew at an average annual rate of 3.6 percent from 1949 through 2007, and many look back longingly at those years as ones of consistent stable growth, punctuated by a few brief recessions. In reality, among the 237 four-quarter stretches during those years, only 12 had four consecutive quarters of growth in the 3.4 percent to 3.8 percent range. By that measure, stable growth existed only 5 percent of the time.
Despite all the turmoil of the Great Recession, after the business peak in the fourth quarter of 2007, and erratic economic developments since then, the slow real GDP growth from 2008 to the present has been just as stable. Two of the 38 four-quarter periods during those years had growth in the 1.2 percent to 1.6 percent range, again 0.2 percentage points on either side of the 1.4 percent average. This is also 5 percent of the time.