Low inflation and low unemployment rate in US economy: Too good to be true?

Interesting speech by Jerome Powell of Federal Reserve.

He discusses how recent data has put US economy in an envious position. But then is it too good to be true?

Today I will focus on the Federal Reserve’s ongoing efforts to promote maximum employment and stable prices. I am pleased to say that, by these measures, the economy looks very good. The unemployment rate stands at 3.9 percent, near a 20-year low. Inflation is currently running near the Federal Open Market Committee’s (FOMC) objective of 2 percent. While these two top-line statistics do not always present an accurate picture of overall economic conditions, a wide range of data on jobs and prices supports a positive view. In addition, many forecasters are predicting that these favorable conditions are likely to continue. For example, the medians of the most recent projections from FOMC participants and the Survey of Professional Forecasters, as well as the most recent Congressional Budget Office (CBO) forecast, all have the unemployment rate remaining below 4 percent through the end of 2020, with inflation staying very near 2 percent over the same period.

From the standpoint of our dual mandate, this is a remarkably positive outlook. Indeed, I was asked at last week’s press conference whether these forecasts are too good to be true–a reasonable question! Since 1950, the U.S. economy has experienced periods of low, stable inflation and periods of very low unemployment, but never both for such an extended time as is seen in these forecasts. Standard economic thinking has long offered an explanation for this: If unemployment were to remain this low for this long, employers would be pushing up wages as they compete for scarce workers, and rising labor costs would feed into more‑rapid price inflation faced by consumers.

This dynamic between unemployment and inflation is known as a Phillips curve relationship, and at times it can pose a fundamental tension between the two sides of the Fed’s mandate to promote maximum employment and price stability. Recent low inflation and unemployment have some analysts asking, “Is the Phillips curve dead?”Others argue that the Phillips curve still lurks in the background and could reemerge at any time to exact revenge for low unemployment in the form of high inflation.

My comments today have two main objectives. The first is to explain how changes in the Phillips curve help account for the somewhat surprising but broadly shared current forecasts of continued very low unemployment with inflation near 2 percent. At the risk of spoiling the surprise, I do not see it as likely that the Phillips curve is dead, or that it will soon exact revenge. What is more likely, in my view, is that many factors, including better conduct of monetary policy over the past few decades, have greatly reduced, but not eliminated, the effects that tight labor markets have on inflation. However, no one fully understands the nature of these changes or the role they play in the current context. Common sense suggests we should beware when forecasts predict events seldom before observed in the economy.

The speech also serves as a very useful way to explain linkages between inflation and unemployment in a macro class…


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