World-Watching: German Industry: Structural Change Underway

[from Deutsche Bank Research]

Production in major industrial sectors in Germany has developed very differently in recent years under the impact of the coronavirus pandemic and energy price shock. For example, manufacturing in electrical engineering rose by 18% compared with the start of 2015. In the chemical industry, there has been a 20% decline over the same period. The differences are not only cyclical, but also structural. In the future, it will be more important to distinguish between Germany as an industrial location and the German industry.

Read the Germany blog [archived PDF].

Economics-Watching: Texas Service Sector Activity Flat, Outlook Continues to Worsen

[from The Federal Reserve Bank of Dallas]

Growth in Texas service sector activity stalled in October, according to business executives responding to the Texas Service Sector Outlook Survey.

Labor market indicators pointed to no growth in employment and a largely stable workweek,” said Jesus Cañas, Dallas Fed senior business economist. “Price pressures remained unchanged while wage growth eased slightly. Perceptions of broader business conditions continued to worsen in October, as pessimism notably increased.”

Key takeaways from the service sector survey:

  • The revenue index fell eight points to 0.7, with the near-zero reading suggesting little change in activity from September.
  • The employment index fell from 2.7 to 0.1, its lowest level in seven months.
  • The input prices index was flat at 37.3 and the selling prices index remained steady at 9.5.
  • The wages and benefits index fell two points to 17.0, approaching its average reading of 15.8.
  • The general business activity index dropped from -8.6 to -18.2, its lowest level since December of last year, while the company outlook index fell to -12.8, its lowest level in 16 months.

Texas Retail Sales Decline

Retail sales declined again in October while retail labor market indicators reflected a contraction in employment and workweeks,” Cañas said. “Retail labor market indicators reflected flat employment and workweeks. Retailers’ perceptions of broader business conditions were mixed.”

Key takeaways from the retail survey:

  • The sales index fell from -4.4 to -18.1, marking its sixth consecutive month in negative territory.
  • The employment index fell 13 points to -12.4 while the hours worked index fell from 0.6 to -12.1.
  • The general business activity index dropped from -10.2 to -23.0.

The Dallas Fed conducts the survey monthly to obtain a timely assessment of activity in the state’s service sector, which represents almost 70 percent of the state’s economy and employs about 9.5 million workers.        

For this month’s survey, Texas business executives were asked supplemental questions on credit conditions. Results for these questions from the Texas Manufacturing Outlook Survey, Texas Service Sector Outlook Survey and Texas Retail Outlook Survey have been released together.

Read the special questions results.

Economics-Watching: “Doing Nothing” Is Still Doing a Lot

[from the Federal Reserve Bank of Philadelphia, speech by Patrick T. Harker President and Chief Executive Officer at the National Association of Corporate Directors Webinar, Philadelphia, PA (Virtual)]

Good afternoon, everyone.

I appreciate that you’re all giving up part of the end of your workday for us to be together, if only virtually.

My thanks to my good friend, Rick Mroz, for that welcome and introduction.

I do believe we’re going to have a productive session. But just so you all know, as much as I enjoy speaking and providing my outlook, I enjoy a good conversation even more.

So, first, let’s take a few minutes so I can give you my perspective on where we are headed, and then I will be more than happy to take questions and hear what’s on your minds.

But before we get into any of that, I must begin with the standard Fed disclaimer: The views I express today are my own and do not necessarily reflect those of anyone else on the Federal Open Market Committee (FOMC) or in the Federal Reserve System.

Put simply, this is one of those times where the operative words are, “Pat said,” not “the Fed said.”

Now, to begin, I’m going to first address the two topics that I get asked about most often: interest rates and inflation. And I would guess they are the topics front and center in many of your minds as well.

After the FOMC’s last policy rate hike in July, I went on record with my view that, if economic and financial conditions evolved roughly as I expected they would, we could hold rates where they are. And I am pleased that, so far, economic and financial conditions are evolving as I expected, if not perhaps even a tad better.

Let’s look at the current dynamics. There is a steady, if slow, disinflation under way. Labor markets are coming into better balance. And, all the while, economic activity has remained resilient.

Given this, I remain today where I found myself after July’s meeting: Absent a stark turnabout in the data and in what I hear from contacts, I believe that we are at the point where we can hold rates where they are.

In barely more than a year, we increased the policy rate by more than 5 percentage points and to its highest level in more than two decades — 11 rate hikes in a span of 12 meetings prior to September. We not only did a lot, but we did it very fast.

We also turned around our balance sheet policy — and we will continue to tighten financial conditions by shrinking the balance sheet.

The workings of the economy cannot be rushed, and it will take some time for the full impact of the higher rates to be felt. In fact, I have heard a plea from countless contacts, asking to give them some time to absorb the work we have already done.

I agree with them. I am sure policy rates are restrictive, and, as long they remain so, we will steadily press down on inflation and bring markets into a better balance.

Holding rates steady will let monetary policy do its work. By doing nothing, we are still doing something. And I would argue we are doing quite a lot.

Headline PCE inflation remained elevated in August at 3.5 percent year over year, but it is down 3 percentage points from this time last year. About half of that drop is due to the volatile components of energy and food that, while basic necessities, they are typically excluded by economists in the so-called core inflation rate to give a more accurate assessment of the pace of disinflation and its likely path forward.

Well, core PCE inflation has also shown clear signs of progress, and the August monthly reading was its smallest month-over-month increase since 2020.

So, yes, a steady disinflation is under way, and I expect it to continue. My projection is that inflation will drop below 3 percent in 2024 and level out at our 2 percent target thereafter.

However, there can be challenges in assessing the trends in disinflation. For example, September’s CPI report came out modestly on the upside, driven by energy and housing.

Let me be clear about two things. First, we will not tolerate a reacceleration in prices. But second, I do not want to overreact to the normal month-to-month variability of prices. And for all the fancy techniques, the best way to separate a signal from noise remains to average data over several months. Of course, to do so, you need several months of data to start with, which, in turn, demands that, yes, we remain data-dependent but patient and cautious with the data.

Turning to the jobs picture, I do anticipate national unemployment to end the year at about 4 percent — just slightly above where we are now — and to increase slowly over the next year to peak at around 4.5 percent before heading back toward 4 percent in 2025. That is a rate in line with what economists call the natural rate of unemployment, or the theoretical level in which labor market conditions support stable inflation at 2 percent.

Now, that said, as you know, there are many factors that play into the calculation of the unemployment rate. For instance, we’ve seen recent months where, even as the economy added more jobs, the unemployment rate increased because more workers moved off the sidelines and back into the labor force. There are many other dynamics at play, too, such as technological changes or public policy issues, like child care or immigration, which directly impact employment.

And beyond the hard data, I also have to balance the soft data. For example, in my discussions with employers throughout the Third District, I hear that given how hard they’ve worked to find the workers they currently have, they are doing all they can to hold onto them.

So, to sum up the labor picture, let me say, simply, I do not expect mass layoffs.

do expect GDP gains to continue through the end of 2023, before pulling back slightly in 2024. But even as I foresee the rate of GDP growth moderating, I do not see it contracting. And, again, to put it simply, I do not anticipate a recession.

Look, this economy has been nothing if not unpredictable. It has proven itself unwilling to stick to traditional modeling and seems determined to not only bend some rules in one place, but to make up its own in another. However, as frustratingly unpredictable as it has been, it continues to move along.

And this has led me to the following thought: What has fundamentally changed in the economy from, say, 2018 or 2019? In 2018, inflation averaged 2 percent almost to the decimal point and was actually below target in 2019. Unemployment averaged below 4 percent for both years and was as low as 3.5 percent — both nationwide and in our respective states — while policy rates peaked below 2.5 percent.

Now, I’m not saying we’re going to be able to exactly replicate the prepandemic economy, but it is hard to find fundamental differences. Surely, I cannot and will not minimize the immense impacts of the pandemic on our lives and our families, nor the fact that for so many, the new normal still does not feel normal. From the cold lens of economics, I do not see underlying fundamental changes. I could also be wrong, and, trust me, that would not be the first time this economy has made me rethink some of the classic models. We just won’t know for sure until we have more data to look at over time.

And then, of course, there are the economic uncertainties — both national and global — against which we also must contend. The ongoing auto worker strike, among other labor actions. The restart of student loan payments. The potential of a government shutdown. Fast-changing events in response to the tragic attacks against Israel. Russia’s ongoing war against Ukraine. Each and every one deserves a close watch.

These are the broad economic signals we are picking up at the Philadelphia Fed, but I would note that the regional ones we follow are also pointing us forward.

First, while in the Philadelphia Fed’s most recent business outlook surveys, which survey manufacturing and nonmanufacturing firms in the Third District, month-over-month activity declined, the six-month outlooks for each remain optimistic for growth.

And we also publish a monthly summary metric of economic activity, the State Coincident Indexes. In New Jersey, the index is up slightly year over year through August, which shows generally positive conditions. However, the three-month number from June through August was down, and while both payroll employment and average hours worked in manufacturing increased during that time, so did the unemployment rate — though a good part of that increase can be explained as more residents moved back into the labor force.

And for those of you joining us from the western side of the Delaware River, Pennsylvania’s coincident index is up more than 4 percent year over year through August and 1.7 percent since June. Payroll employment was up, and the unemployment rate was down; however, the number of average hours worked in manufacturing decreased.

There are also promising signs in both states in terms of business formation. The number of applications, specifically, for high-propensity businesses — those expected to turn into firms with payroll — are remaining elevated compared with pre-pandemic levels. Again, a promising sign.

So, it is against this full backdrop that I have concluded that now is the time at which the policy rate can remain steady. But I can hear you ask: “How long will rates need to stay high.” Well, I simply cannot say at this moment. My forecasts are based on what we know as of late 2023. As time goes by, as adjustments are completed, and as we have more data and insights on the underlying trends, I may need to adjust my forecasts, and with them my time frames.

I can tell you three things about my views on future policy. First, I expect rates will need to stay high for a while.

Second, the data and what I hear from contacts and outreach will signal to me when the time comes to adjust policy either way. I really do not expect it, but if inflation were to rebound, I know I would not hesitate to support further rate increases as our objective to return inflation to target is, simply, not negotiable.

Third, I believe that a resolute, but patient, monetary policy stance will allow us to achieve the soft landing that we all wish for our economy.

Before I conclude and turn things over to Rick to kick off our Q&A, I do want to spend a moment on a topic that he and I recently discussed, and it’s something about which I know there is generally great interest: fintech. In fact, I understand there is discussion about NACD hosting a conference on fintech.

Well, last month, we at the Philadelphia Fed hosted our Seventh Annual Fintech Conference, which brought business and thought leaders together at the Bank for two days of real in-depth discussions. And I am extraordinarily proud of the fact that the Philadelphia Fed’s conference has emerged as one of the premier conferences on fintech, anywhere. Not that it’s a competition.

I had the pleasure of opening this year’s conference, which always puts a focus on shifts in the fintech landscape. Much of this year’s conference centered around developments in digital currencies and crypto — and, believe me, some of the discussions were a little, shall we say, “spirited.” However, my overarching point to attendees was the following: Regardless of one’s views, whether in favor of or against such currencies, our reality requires us to move from thinking in terms of “what if” to thinking about “what next.”

In many ways, we’re beyond the stage of thinking about crypto and digital currency and into the stage of having them as reality — just as AI has moved from being the stuff of science fiction to the stuff of everyday life. What is needed now is critical thinking about what is next. And we at the Federal Reserve, both here in Philadelphia and System-wide, are focused on being part of this discussion.

We are also focused on providing not just thought leadership but actionable leadership. For example, the Fed rolled out our new FedNow instant payment service platform in July. With FedNow, we will have a more nimble and responsive banking system.

To be sure, FedNow is not the first instant payment system — other systems, whether operated by individual banks or through third parties, have been operational for some time. But by allowing banks to interact with each other quickly and efficiently to ensure one customer’s payment becomes another’s deposit, we are fulfilling our role in providing a fair and equitable payment system.

Another area where the Fed is assuming a mantle of leadership is in quantum computing, or QC, which has the potential to revolutionize security and problem-solving methodologies throughout the banking and financial services industry. But that upside also comes with a real downside risk, should other not-so-friendly actors co-opt QC for their own purposes.

Right now, individual institutions and other central banks globally are expanding their own research in QC. But just as these institutions look to the Fed for economic leadership, so, too, are they looking to us for technological leadership. So, I am especially proud that this System-wide effort is being led from right here at the Philadelphia Fed.

I could go on and talk about fintech for much longer. After all, I’m actually an engineer more than I am an economist. But I know that Rick is interested in starting our conversation, and I am sure that many of you are ready to participate.

But one last thought on fintech — my answers today aren’t going to be generated by ChatGPT.

On that note, Rick, thanks for allowing me the time to set up our discussion, and let’s start with the Q&A.

[archived PDF of the above speech]

Economics-Watching: FedViews for January 2023

[from the Federal Reserve Bank of San Francisco]

Adam Shapiro, vice president at the Federal Reserve Bank of San Francisco, stated his views on the current economy and the outlook as of January 12, 2023.

  • While continuing to cool over the last several months, 12-month inflation remains at historically high levels. The headline personal consumption expenditures (PCE) price index rose 5.5% in November 2022 from a year earlier. This marks a decline in inflation to a level last observed in October 2021, but still well above the Fed’s longer-run goal of 2%. A portion of the inflation moderation is attributable to recent declines in energy prices. Core PCE inflation, which removes food and energy prices, has shown less easing.
  • Owing to fiscal relief efforts and lower household spending over the course of the pandemic, consumers accumulated over $2 trillion dollars in excess savings, based on pre-pandemic trends. Since then, consumers have drawn down over half of this excess savings which has helped support recent growth in personal consumption expenditures. A considerable amount of accumulated savings remains for some consumers to support spending in 2023.
  • In the wake of the pandemic, consumer spending patterns shifted away from services towards goods. While there appears to be some normalization of spending behavior, this shift has generally persisted. Real goods spending remains significantly above its pre-pandemic trend, driven by strong demand for durables such as furniture, electronics, and recreational goods. Spending on services has shown a resurgence but remains below its pre-pandemic trend.
  • Supply chain bottlenecks for materials and labor remain a constraint on production, although there are some recent signs of easing. The fraction of manufacturers who reported operating below capacity due to insufficient materials peaked in late 2021 and has moderately declined over the past year. However, the fraction of manufacturers reporting insufficient labor has persisted at high levels.
  • The labor market remains tight, despite some signs of cooling. The number of available jobs remains well above the number of available workers, although vacancy postings have been trending down in recent months. The tight labor market has put continued upward pressure on wages and labor market turnover.
  • A decomposition of headline PCE inflation into supply– and demand-driven components shows that both supply and demand factors are responsible for the recent rise in inflation. The surge in inflation in early 2021 was mainly due to an increase in demand-driven factors. Subsequently, supply factors became more prevalent for the remainder of 2021. Supply-driven inflation has moderated significantly over recent months, while demand-driven inflation remains elevated.
  • The Federal Open Market Committee (FOMC) raised the federal funds rate by 50 basis points at the December meeting to a range of 4.25 to 4.5%. This cycle of continued rate increases since March of last year represents the fastest pace of monetary policy tightening in 40 years. The increase in the federal funds rate has been accompanied by a gradual reduction in the size of the Federal Reserve’s balance sheet.
  • Economic activity in sectors such as housing, which is sensitive to rising interest rates, has slowed considerably in recent months. Housing starts have fallen steadily over the past year, as have other housing market indicators, such as existing home sales and house prices.
  • Although the labor market is currently very strong, financial markets are pointing to some downside risks. Namely, the difference between longer- and shorter-term interest rates has turned negative, which historically tends to occur immediately preceding recessions. It remains unclear whether lower longer-term yields are indicative of anticipated slower growth or lower inflation.
  • Short-term inflation expectations remain elevated relative to their pre-pandemic levels in December 2019. Consumers are expecting prices to rise 5% this year, while professional forecasters are expecting prices to rise 3.5%. Longer-term inflation expectations remain more subdued, indicating that both consumers and professionals believe inflation pressures will eventually dissipate.
  • Rent inflation is expected to remain high over the next year. The prices for asking rents have grown quite substantially over the last two years. As new leases begin and existing leases are renewed, these higher asking rents will flow into the stock of rental units, putting upward pressure on rent inflation.
  • We are expecting inflation to moderate over the next few years as monetary policy continues to restrain demand and supply bottlenecks continue to ease. We anticipate that it will take some time for inflation to reach the Fed’s longer-run goal of 2%.
Inflation is cooling, but remains very high
Savings are boosting consumer demand
Goods consumption remains elevated
Supply shortages are prevalent, but easing
Labor market remains tight, but is cooling
Both supply and demand drive inflation
Monetary policy tightening is having real effects
Yield curve is inverted, signaling recession risk
Short-term inflation expectations remain elevated
High rent inflation is in the pipeline
Inflation likely to remain above 2% for some time

[Archived PDF]

Read other issues from FedViews.

Climate-Watching: A Collision of Economics and History: In Pennsylvania, the Debate over Climate Is a Bitter One

The state has both a long history of environmental action and a longstanding dependence on fossil fuels.

[from Inside Climate News, by David Shribman, July 17, 2022]

This is a state where natural gas production reached a record 7.1 trillion cubic feet in 2020, the most of any state outside Texas and more than the energy supplied by the state’s nuclear power plants. It’s a state that has 49 underground gas storage sites, more than any other in the nation.  Its coal production ranks behind only Wyoming and West Virginia, and only Wyoming and Texas export more total energy to other parts of the country.

This is also a state where voters will select a new governor and a new senator in November. No state has more vital elections this year; no state has a more complicated and more contentious political culture; and no state provides a better test case for environmental issues and for the future of the climate-change debate.

Welcome to Pennsylvania.

Don’t pack a sweater: the average temperature in the state has risen by 2.8 degrees Fahrenheit since the first Earth Day, in 1970, a bigger increase than the national average.

Don’t breathe deeply: the state’s two major cities, Philadelphia and Pittsburgh, are among the nation’s worst 25 metropolitan areas for annual particulate air pollution

And don’t fail to note the irony—of a state whose economy and lifestyle are unusually dependent on fossil fuels but whose history is unusually rich in the love of nature and the protection of the environment. It is this collision of economics and history that makes environmental issues so emotional, the debate so bitter, the outcome so vital.

Pennsylvania was the home of John J. Audubon, who cultivated in Americans a love of bird life; Rachel Carson, whose clarion call about the environment jolted the country and shook the Kennedy administration; John Chapman, known to school children nationwide as Johnny Appleseed; J. Horace McFarland, a photographer and conservationist celebrated as the Father of the National Park Service; Harold L. Ickes, the pathfinding Secretary of the Interior during the Franklin D. Roosevelt years who shored up perhaps the least effective and most corrupt arm of government while elevating the standards and practices of the National Park Service; and Jerome Rodale, the publisher whose books gave voice to the ethos of sustainable agriculture. And it was the adopted home of William Penn, the founder of the colony that would bear his name and the author of a conservation edict requiring that 20 percent of the land in the Province of Pennsylvania be preserved as wooded. It is no surprise that Pennsylvania was one of the first states to adopt an Environmental Bill of Rights.

But Pennsylvania also was the setting for environmental milestones of an entirely different type. In Donora, a 1948 smog episode killed 20 people and saddled some 40 percent of the town’s population with respiratory disease. A third of a century later, the partial meltdown of Unit 2 of the Three Mile Island nuclear plant in Dauphin County spewed radioactivity into the Harrisburg area. 

The state has had multiple mine disasters and the subsequent contamination of nearby fields and streams. As early as 1883, the explorer and adventure travel writer Willard Glazer wrote that Pittsburgh’s industry was “rendered possible by the coal which abounds in measureless quantity in the immediate neighborhood of the city”—and which contributed to the poisoning of many of the area’s waterways and the despoiling of the air. As late as 1940, 81 percent of the city’s dwellings burned coal. The emissions from the steel mills that helped the country win two world wars and build a robust mass-consumer economy only added to the environmental distress.

This duality is part of, defines all of, Pennsylvania’s natural and political history.  It is embedded in the origin story of Pennsylvania and reinforced in contemporary history. In the WPA Guide to Pennsylvania, the writers of the New Deal-era product of the Federal Writers Project spoke in 1940 of how the main plant of the Pittsburgh Plate Glass Company in Ford City, Pennsylvania, “extends for a mile along Third Avenue in a series of long squat units composed of red brick,” and how the state’s Red Hills were exceeded only in Belgium as “the finest farm section in the world.” Precisely three-quarters of a century ago, in his classic 1947 book, Inside U.S.A., the journalist John Gunther wrote, “To a degree the story of Pennsylvania is the story of iron, coal, and steel. Yet of its 26 million acres, almost half is forest!”

A state known for producing metals and fouling the air is also a state known for hunting grouse, pheasant, deer and bear. A state teeming with factory workers is a state loaded with farmers. A state with two major power centers, Philadelphia and Pittsburgh, is a state where elections often are decided in the agricultural “T” between the two. A state known for building belching steel plants is also a state where, this spring, the owners of Fallingwater, the Frank Lloyd Wright masterpiece, announced that they would install solar panels on the iconic house to offset the power used at the site on Bear Run in Fayette County. And when it comes to environmental issues, Pennsylvania is a state where manufacturing and banking interests have enormous influence in the stately Capitol in Harrisburg, and also a state full of climate activists determined to hold industry in check and battle climate change.

“It is particularly difficult in Pennsylvania to come to any agreement on environmental issues because coal and natural gas have countervailing pressure against attempts to deal with climate change,” said Joel A. Tarr, a Carnegie Mellon University historian who studies the effect of technology on the urban environment. “When you tell people that we have a problem with air quality here, their response is that it used to be much worse. This is a place where we won’t have a water-quality solution until we have a cholera epidemic and we won’t address climate change until we have a major catastrophe that brings it home to Pennsylvania.”

Not that there haven’t been efforts. “A generalized good always takes a back seat to a specific interest,” Gov. Tom Wolf, a Democrat, told me in an interview for this article. “We all benefit from a healthy environment, but there are specific interests that are specifically harmed if we do the right thing. Those specific interests have a lot of power in places like Harrisburg.”

The frequent result of these countervailing impulses and competing interests: paralysis on environmental matters, even as the latest United Nations report, published in April, warned that the world was on a path to a rate of global warming more than double the 2.7-degrees Fahrenheit set as the preferred global goal in 2015 in Paris.

U.N. Secretary General António Guterres warned that the result would be “unprecedented heatwaves, terrifying storms, widespread water shortages and the extinction of a million species of plants and animals,” adding, “This is not fiction or exaggeration. It is what science tells us will result from our current energy policies.”

 A City (and State) in Crisis

As man proceeds toward his announced goal of the conquest of nature, he has written a depressing record of destruction, directed not only against the earth he inhabits but against the life that shares it with him.

Rachel Carson, in Silent Spring

In many ways, Pittsburgh—once smoky, still gritty, now proud of its “eds-and-meds” economy, its edgy youth culture and yeasty locavore restaurant scene—stands as a symbol of Pennsylvania’s environmental and climate crisis.

In the past half century, the city’s average temperature has risen by 2.8 degrees, according to figures compiled by Climate Central—a jarring result for a city where the local political grandees like to emphasize how the area has moved beyond its heavy-manufacturing past. Even with the dramatic decline in the steel industry, Pittsburgh remains the 10th worst city in the country in terms of the presence of short-term particulate matter, and the Breathe Meter indicator that monitors the area’s air has found that 88.5 percent of metro areas in the country have cleaner air. Moreover, a study by Community Partners in Asthma Care found that the rate of asthma in Pittsburgh-area school children is nearly three times the national average.

For generations, no essay on the environment of Pennsylvania was complete without citing Charles Dickens’ characterization of mid-19th century Pittsburgh as “hell with the lid lifted,” or Lincoln Steffens’ complaint about the city’s “smoky gloom” and the “volcanic light upon the cloud of mist and smoke” that appeared with the periodic opening of the blast furnaces. When my wife and I bought a house in Pittsburgh two decades ago—when almost the entire steel industry had closed down in the area—we paid thousands of dollars to have a century’s worth of soot blasted from the brick facade.

All of that before the word “fracking” was introduced into the lexicon of the Pennsylvania debate.

“There is gas in the ground and people have been taking it out of the ground since before I was governor,” Wolf said in the interview. “If I could snap my fingers, we would go completely to wind and solar. I haven’t figured out how to do this. The job is to manage the transition to that energy future.”

Republicans in recent years have sought to deregulate the natural gas industry, expand drilling, ease stipulations for gas permits, open state parklands for energy extraction and open new opportunities for gas pipelines, having the state subsidize them.

“These things were not always Republican goals,” said David Hess, who was secretary of the Pennsylvania Department of Environmental Protection under Republican Governors Tom Ridge and Mark Schweiker. “Republicans once had environmental issues as a pretty high priority. Only recently have Republicans changed their approach. This issue is no longer bipartisan, and that applies especially to climate change. But the only way we can break the loop we are on is to do something different, and yet industry and their Republican allies want more and more. Putting all the stuff in the air from fossil fuels cannot be good, especially when we have clean alternatives.”

And yet the Keystone State has not been entirely a conscientious objector to environmental initiatives.

At a time when there was so much soot in the air that Pittsburgh kept its street lights on all day long and businessmen were forced to change their soiled shirts after returning from a walk to a lunch appointment, Mayor David Lawrence undertook a dramatic anti-smoke campaign in 1946 that greatly improved the air quality in the city. “I am convinced that our people want clean air,” the mayor said in his first inaugural address. “There is no other single thing which will so dramatically improve the appearance, the health, the pride, the spirit of the city.”

Lawrence was not alone. “The advocates of the Pittsburgh Renaissance conceived of decreased pollution as a means of assisting the transition of the city from a heavy-industry to a service economy by improving, modernizing, and reconstructing its central business district,” Stefano Laconi, who teaches the history of the Americas at the University of Florence, wrote in a 1999 essay in the journal Pennsylvania History. He argued that the initiative provided Lawrence “not only with the foundation of a public-private partnership but also with the basis of a bipartisan political coalition with local Republican moguls like Richard King Mellon.”

Years later, Republican Gov. Ridge, with Democratic support, began his administration with an initiative to clean up and redevelop brownfield sites. At the same time, the legislature won national attention by reorganizing the state’s approach to these issues, creating separate departments of Environmental Protection, which concentrates on protecting the air, water and land from pollution, and Conservation and Natural Resources, focused on state parks and state forests.

“At the beginning of my administration, I issued a challenge to Pennsylvania to become a national leader in finding new ways to protect our environment while promoting economic progress, to provide for the needs of the present without compromising the ability for future generations to meet needs of their own, and to think in terms of sustainability, with both the economy and our environment,” Ridge told me.  

The governor was fond of quoting the adage, “We do not inherit the earth from our ancestors; we borrow it from our children.” As governor, he said that,“I would often remind myself that the air we breathe and the water we drink should never be taken for granted.”

Much to be Done and an Election That Matters

The fact that a man is to vote forces him to think.

Jonathan Chapman, known as Johnny Appleseed

Ordinarily, the multi-interest collision of jobs and climate, energy and environment, might be top-shelf issues in a state that ranks second only to Texas in energy production and that had the largest increase in natural-gas production in the last decade. But that collision is a side show rather than the main event.

“All of these candidates need to speak up and tell us what they would do about the energy situation and the climate crisis that is growing more critical by the minute,” said Larry Schweiger, a former president of the National Wildlife Federation, PennFuture and the Western Pennsylvania Conservancy. “It is very frustrating to see candidates for governor and the Senate not making an effort to say how they would address these urgent issues. Both parties are guilty of  this, and it is a big omission and a big problem.”

Now Democratic Attorney General Josh Shapiro and Republican state Sen. Douglas Mastriano are facing off for governor and Democratic Lt. Gov. John Fetterman and Republican celebrity doctor Mehmet Oz are fighting for the U.S. Senate seat being relinquished by GOP Sen. Patrick Toomey

The four will face questions about their commitment to climate change with new urgency—and new stakes. And the pressure may well come from a newly critical group of voters: young people.

A Harris Poll survey conducted with 4-H found just fewer than half of teenagers believe political and global leaders are taking meaningful action to protect the environment. There is reason to believe that the top tier of teenagers, eligible to vote, and their older brothers and sisters will be motivated and perhaps mobilized by these issues.

“There’s no question that environmental issues are far more critical for younger voters,” said Steven Farnsworth, the political scientist who is director of University of Mary Washington’s Center for Leadership and Media Studies in Virginia. “This has been going on since the first Earth Day. It has to do with the fact that younger people are going to be on this planet longer than older people.”

The approach that these four nominees bring to these matters is important. “It’s not about issues, it’s about values,” said John Della Volpe, director of polling at Harvard Kennedy School of Government’s Institute of Politics and the author of the newly published How Gen Z is Channeling Their Fear and Passion to Save America. “And the degree to which candidates can connect climate change into values, and display that they are thinking about the future, they could affect the turnout of young people and how they do vote.”

There is much to be done. Pennsylvania ranks 19th among the states in the rate of growth for wind power, according to the PennEnvironment Research and Policy Center, and 23rd among the states in the rate of growth for solar power. The potential is great; if solar units were placed on the roofs of Pennsylvania’s big-box stores, for example, the result could be the annual production of more than 3,000 gigawatt-hours of clean electricity. There are bills in the legislature to require the state’s suppliers of electricity to generate nearly a third of their energy from renewable sources by 2030 and to put the state on a course to having 100 percent of its energy needs provided by wind and solar energy and other sources by the middle of the century.

Much of the emphasis will be on the state level, which is why the gubernatorial race between Shapiro, the Democratic attorney general, and GOP state Sen. Mastriano is so critical.

Shapiro speaks easily about clean energy, says he believes that more electric-vehicle infrastructure investments must be made, and pledges strict monitoring of the state’s utility companies. But he has broken with Gov. Wolf over whether the state should join the Regional Greenhouse Gas Initiative, known as RGGI, which puts a price and descending cap on carbon emissions. With an eye toward the power of the state’s building trades, he believes RGGI will be ineffective and will cause hardship among the state’s energy workers and companies.

As the state’s Democratic Senate candidate, Lt. Gov. Fetterman speaks of the climate issue as an “existential crisis” and argues that the jobs-versus-environment calculus represents a false choice. “We still need to make stuff in this country, you know?” A onetime advocate of a moratorium on new fracking sites, he now sees a rationale for a limited, perhaps temporary, expansion. “I have been steadfastly talking about how important it is that we retain the manufacturing jobs and the energy jobs in Pennsylvania that currently provide our energy security,” he said at a debate at Carnegie Mellon University, but added, “We also must acknowledge and recognize that we have to trend …. away from these.”

The Republican candidates in these two high-profile races take substantially different positions from their Democratic rivals. Oz, the Senate candidate, has abandoned his onetime advocacy of strict environmental regulation and calls for the “freedom to frack.” Mastriano, the Republican gubernatorial nominee, has argued that Wolf’s RGGI plan would “do far more harm than good” and this spring he submitted legislation to ban the federal government from regulating coal and gas extraction in Pennsylvania and to exempt the state’s industrial plants from the federal wastewater and air pollution rules. “We’re going to open up our energy sector like you’ve never seen,” Mastriano said at his victory celebration after he won the GOP primary.

A Monumental Figure

Unless we practice conservation, those who come after us will have to pay the price of misery, degradation, and failure for the progress and prosperity of our day.

Gifford Pinchot

If there is one symbol of the tensions, perspectives, history and impulses of Pennsylvania in environmental matters it is not the gentle Audubon, who nurtured a love of birds in the heart and mind of the nation, nor the hard-faced leaders of power plants and coal mines. It is not the passionate Carson nor the resolute lobbyists who besiege the legislative chambers in Harrisburg. All are part of the Keystone State culture, but none of them personifies the colliding interests in this vital and emotional area of political conflict.

Only one person does, and that is Gifford Pinchot.

Today, Pinchot is largely a forgotten figure, overshadowed as a conservationist by John Muir, eclipsed as a visionary by Theodore Roosevelt. Today, Gaylord Nelson, the late senator from Wisconsin and the founder of Earth Day, is regarded as the political magus of the conservation movement, a title once plausibly claimed by Pinchot. Today the world regards Wangari Maath, the Kenyan activist who founded the Green Belt Movement and won the 2004 Nobel Peace Prize, as the most celebrated troubadour and warrior for the environment.

All these titles once belonged to Pinchot, a monumental figure who was the 28th governor of the Commonwealth of Pennsylvania. He served two terms in the Capitol and lived in a family home named Grey Towers, just outside the tourist town of Milford, Pennsylvania. The home is now a National Historic Site and home to the Pinchot Institute for Conservation, dedicated to fashioning innovative responses to conservation and environmental challenges.

Pinchot, who died in 1946, went to his grave with a green-plated resume: First chief of the U.S. Forest Service. Chief of the U.S. Division of Forestry. Head of the Pennsylvania forestry division. At one time, the term “Pinchotism” was derided in Congress by business interests the way “Reaganomics” was criticized by early 1980s Democrats—until Pinchotism, like Reagonomics, was redeemed in the public eye.

And yet Pinchot does not wear an unblemished hero’s halo in history. Until recent damaging disclosures, that belonged to his chief rival, John Muir, his one-time ally and patron, though the shine on Muir was darkened in 2020, when Michael Brune, executive director of the Sierra Club that Muir helped found in 1892, cited him for having “made derogatory comments about Black people and Indigenous peoples that drew on deeply harmful racist stereotypes, though his views evolved later in his life.”

But in the long-ago conflict between Muir and Pinchot that spanned the period 1908 to 1913 and spilled over into later years is a story that captures the conflict at the heart of the environmental issue in the nation—and in Pinchot’s home state.

In the perspective of today, Pinchot had an ability, in the phrasing of his biographer, Char Miller, “to maintain what might seem like contradictory impulses—the desire to live simultaneously and within nature, to exult in its splendors while exploring its resources.” But in his titanic clash with Muir, Pinchot was cast as the bête noire of the movement he plausibly could claim to have helped create.

Muir was all about preservation and Pinchot was about wise or multiple uses of the land,” Douglas Brinkley, the Rice University historian who wrote about the PinchotMuir conflict in his 2010 The Wilderness Warrior, said in an interview. “The dispute was over what was conservation. Muir became a folk hero through the long shadow of the Sierra Club but Pinchot never had a legacy organization group.”

The venue of the clash was the Hetch Hetchy Valley in Yosemite National Park, but its implications extended nationwide and the forces at play continue to collide in Pennsylvania. Pinchot, a close advisor and friend to Theodore Roosevelt, was caught in the vise created by the moral passion of conservationists and the physical thirst of Californians. San Francisco wanted water, early environmentalists worshiped wilderness. There was no middle ground, though Pinchot was caught in the middle of the struggle.

It was, as the Library of Congress would characterize it a century later, “a division between those committed to preserving the wilderness and those more interested in efficient management of its use.” The two combatants had conflicting profiles: Pinchot was an insider, Muir was an outsider. Thus Muir claimed the moral high ground as the protector of the outdoors. The battle between the two men had its origins in Muir’s evolution to a view that, as Miller characterized it in his monumental 2001 Gifford Pinchot and the Making of Modern Environmentalism, “the practice of forestry and the preservation of wilderness were incompatible, a tentative conclusion that would harden into conviction in the first years of the new century.” The result was temporarily to place Pinchot, politically if not emotionally—and supremely awkwardly—in the same camp as his traditional opponents, business executives with a lust for land and lucre.

Pinchot saw this issue as a struggle between “the extreme desirability of preserving the Hetch Hetchy in its original beauty” against the legitimate water needs of San Francisco and other communities in the Bay area. Muir, in a letter to Pinchot, said the proposal to flood the valley to provide water for “the dear people” was “full of graft,” later characterizing it as a moral outrage and a mortal threat to wilderness values. It was a classic confrontation between a master of the political world and a mystic of the natural world.

The struggle wore on for years. Later Pinchot would tell a congressional hearing that “injury to Hetch Hetchy by substituting a lake for the present swampy shore of the valley…is altogether unimportant when compared with the benefits to be derived from its use from a reservoir.”

In the end, Hetch Hetchy was flooded and, though Pinchot remained prominent in conservation circles—he was advising Franklin Delano Roosevelt on these matters as they related to the future United Nations as late as the World War II years—his reputation was no longer unsullied.

The crosswinds of the Hetch Hetchy controversy—the issues it raised, the passions it ignited, the arguments it prompted—now blow as a gale through Pinchot’s home state. They are the prevailing winds of Pennsylvania.

A Step in the Right Direction

A true conservationist is a man who knows that the world is not given by his fathers, but borrowed from his children.

John J. Audubon

Coal once accounted for 60 percent of all electricity generated in Pennsylvania, a rate that has declined by more than half; today only a handful of large grid-connected coal-fired electric plants operate in the state. That represents a steep decline, though Homer City Generation said this spring that it would not follow through with tentative plans to deactivate its units in Indiana County. “This decreasing dependence on these sorts of plants shows we are going in the right direction in reducing climate-changing emissions from coal-fired plants,” said Hess, the former GOP environmental commissioner. “But it is mostly because of the competition between natural gas and coal. The problem is that we are now getting down to the point in the power sector that we can’t get additional big emission reductions. There aren’t more plants to close to give us those reductions. So we have to adopt other kinds of strategies.”

Pennsylvania has more than 86,000 miles of streams, more than any state in the lower 48. The miles of these waterways that can support brook trout are dwindling, in part because of climate change and in part because the invasion of the hemlock wooly adelgid insect has infected the shoreline hemlock trees that otherwise would provide shade for the streams.

This is only the latest incarnation of the centuries-long decline in the health of the state’s waterways. In the 18th century, the British army captain Harry Gordon pronounced the site of the confluence of Pittsburgh’s three rivers as “the most healthy, the most pleasant, the most commodious, the most fertile spot of Earth known to European people.” A century later, another British observer said that in Pittsburgh, “Man befouled the streams, bedraggled their banks, ripped up the cliffs, hacked down the trees, and dumped refuse in their stead.”

But the environmental crisis is not confined to western Pennsylvania. To take a random reading of air pollution in the state, Pennsylvania’s worst air quality on April 5 was in Mechanicsburg, outside Harrisburg, in the center of the state, followed by New Bloomfield, 23 miles away, according to IQ Air real-time figures. At the same time, Wilkes-Barre, with an average increased temperature of 3.3 degrees since 1970, substantially beats the average national rate of 2.6 degrees. So does State College, at an increase of 3 degrees.

Over the decades, the emphasis has changed from “conservation” to “stopping climate change,” with the threat of neighborhood contamination (the late 1970s), acid rain (the early 1980s), and the ozone hole (the mid 1980s) joined by global warming, a term introduced into the scientific and then the political lexicon when James Hansen, a NASA atmospheric expert warned a Congressional committee in 1988 that he and a set of climate modelers believed they could “confidently state that major greenhouse climate changes are a certainty.” He told the lawmakers that “the global warming predicted in the next 20 years will make the Earth warmer than it has been in the past 100,000 years.”

Opposition from an Unusual Coalition

To contemplate nature, magnificently garbed as it is in this country, is to restore peace to the mind, even if it does make one realize how small and petty and futile the human individual really is.

Harold Ickes

Many of the political tensions in Pennsylvania were visible in the debate that began last year—and became even more bitter this year—over RGGI. Gov. Wolf made becoming a part of the alliance of 10 New England and Middle Atlantic states—and, as a result reducing Pennsylvania’s greenhouse gas emissions by as many as 227 million tons by 2030—one of the top priorities of his final year in office.

The result was opposition by an unusual coalition of Republicans and labor unions, who argued that the governor’s plan would reduce jobs in the state.

“The ‘jobs-versus-environment’ framework is almost always part of these debates,” said Christopher Borick, a political scientist at Muhlenberg College in Allentown. “Environmental laws are for the public good—to protect the health and well being of individuals—so it is hard to argue against that. So what do you use as your argument? Jobs. It is sometimes a false choice, and often the environmentally sensitive approach can be a good economic choice. But politically, it is very powerful argument even if the reality isn’t the case.”

Last December, the Republican-controlled legislature passed a resolution that would halt the governor’s effort to join RGGI. The governor then exercised his veto, citing technicalities in the resolution and arguing that joining the group “is a vital step for Pennsylvania to reduce carbon emissions and achieve our climate goals.” When a stay issued by the Commonwealth Court expired in late April, the Wolf administration went ahead and published the regulation, and in less than a day the odd-couple coalition of coal unions and coal companies went to court to fight the order, which required operators of power plants fired by coal and natural gas to buy allowances for every ton of carbon dioxide they emitted.

“I want to give $150 million a year to a board headed by organized labor,” the governor, referring to a trust fund to aid individuals displaced by the transition to sustainable energy sources, told Inside Climate News as the controversy raged. “What don’t they like about this?”

In a separate interview, state Sen. Wayne Fontana, the chairman of the chamber’s Democratic Caucus and a member of the Game and Fisheries Committee, described the resistance mounted by Republicans in the legislature as “a wedge to use against the Democratic gubernatorial candidate in the fall.” He said the state has taken substantial steps to address environmental threats, arguing, “We have done a lot with lead in the water, we have beaten up air and water polluters.”

A Lack of Urgency

And so we live in a time when change comes rapidly—a time when much of that change is, at least for long periods, irrevocable. This is what makes our own task so urgent. It is not often that a generation is challenged, as we today are challenged. For what we fail to do—what we let go by default, can perhaps never be done.

Rachel Carson, accepting the Audubon Medal of the National Audubon Society in 1963

Now the challenge is global warming, which dwarfs the threat from 19th century industrial pollution and 20th century acid rain.

This past year did not have a silent spring when it came to the climate change issue. Indeed, the reports were more dire, the warnings more urgent, the lack of substantial attention more dangerous. The world, and Pennsylvania, face dramatic alternative outcomes from their actions or inaction. One choice might redound to cities underwater or lower energy consumption as a result of the creation of, in the characterization of the Intergovernmental Panel on Climate Change, of  “compact, walkable cities.” Another might be a continued reliance on private, gasoline-powered automobiles, trucks and buses or the “electrification of transport in combination with low-emission energy sources, and enhanced carbon uptake and storage using nature.”

The April report of the IPCC, the United Nations group that assesses science in relation to global warming, was sobering if not chilling. The bottom line: Net emissions are continuing to rise. “It’s now or never, if we want to limit global warming to 1.5°C [2.7°F] without immediate and deep emissions reductions across all sectors,” said Jim Skea, co-chair of the working group that produced the latest report, “it will be impossible.”

That will require what the IPCC working group co-chair Priyadarshi Shukla described as “the right policies, infrastructure and technology…to enable changes to our lifestyles and behavior.” And it will require a combination of policies and planning.

“We are opposed to long-term planning here in Pennsylvania,” said Professor Tarr of Carnegie Mellon University. “We react to crises, and we do so inadequately. People here generally have no sense of urgency about these kinds of issues.”

David Shribman served as editor of the Pittsburgh Post-Gazette for 16 years and won a Pulitzer Prize for his reporting on American political culture as Washington bureau chief of The Boston Globe. He now writes a nationally syndicated column, contributes a separate column to The Globe and Mail in Canada, and teaches American politics at both McGill University’s Max Bell School of Public Policy and Carnegie Mellon University.

Economy Watching: Philadelphia Fed

from the Federal Reserve Bank of Philadelphia:

Fed President Patrick Harker Says It Will “Soon” Be Time to Taper Asset Purchases

Philadelphia Fed President Patrick Harker told a virtual audience at the Prosperity Caucus in Washington, D.C., that the asset purchases once necessary during the acute phase of the COVID-19 pandemic are no longer effective as a tool for supporting the economy. He also said the U.S. economy created millions of jobs in recent months, but “we just can’t fill them.”

Economic Outlook: Growth Despite Constraints

Good evening! Thanks so much for having me. I understand that when this group meets in person there is usually pizza involved — so I intend to collect on that debt next time we do this in the flesh.

I plan to offer a few remarks about the state of the national economy and the path of Federal Reserve policy. Then we can move to our Q&A, which I’m really looking forward to.

But before I do that, I need to give you the standard Fed disclaimer: The views I express today are my own and do not necessarily reflect those of anyone else on the Federal Open Market Committee (FOMC) or in the Federal Reserve System.

Fed Structure

I know this group encompasses a very diverse crowd — we have everyone from House staffers to Senate staffers here. So, just in case anyone doesn’t know, I want to begin by giving you a very brief explanation of what, exactly, a regional Federal Reserve Bank is. Our nation’s central bank, after all, is quite unusual — unique, even — in its design.

The configuration of the Federal Reserve System — a central bank with a decentralized structure — owes its existence to the 1913 Federal Reserve Act. It is something of a testament to old-fashioned American compromise and reflects the unique demands of the United States and our economy.

The System consists of a Board of Governors, which sits in Washington, and 12 regional Banks around the country.

The Board seats seven governors, including the Chair. Each regional Bank has its own president and board of directors, which is made up of business, banking, and community leaders from the area. Fundamentally, this provides the Fed with a perspective — within each District — of the sectors and issues that make the region tick. Mine is the Third District, which encompasses eastern Pennsylvania, South Jersey, and the state of Delaware. We’re the smallest District geographically, but I like to think we punch above our weight.

The FOMC, which is responsible for monetary policy, is composed of the Fed’s governors and regional Bank presidents. Regional Bank presidents don’t always get to vote. Most of us rotate into a voting position every three years, but the governors always vote, as does the president of the New York Fed. New York, owing to the presence of Wall Street, enjoys something of a “first among equals” status within the System.

While the rest of us don’t always vote, we do always represent our Districts and play a part in the discussion. If you were at a normal FOMC meeting, you probably wouldn’t be able to tell a voting member until the end of the meeting when it’s time to raise hands. Everybody contributes.

The Fed’s decentralized nature is, in my view, a unique strength. We’re making national policy, but we’re doing it for an enormous country, and the averages of economic data can obscure realities on the ground. Conditions look very different in Philadelphia, Dover, or Washington than they do in Dallas, Salt Lake City, or Honolulu. This System gives a voice to a range of localities and sectors. It also allows us to focus on regional issues within each Bank’s District.

The United States has a unique set of needs. It’s easy to forget that we’re an outlier because we’re such a massive country: Only Russia and Canada are bigger geographically, only China and India have larger populations, and no one country has a bigger economy, at least for now. And that economy is vast, spreading across sectors and natural resources in a way that is not typical of other nations.

So, it makes sense that we have a System that feeds back information from around the country.

The State of the Economy

And what that information is telling us is that, for the past 18 months, the economy has moved in tandem with the waxing and waning of the COVID-19 pandemic. During periods when case rates and hospitalizations have declined, the economy has surged as American consumers have voted with their wallets. When COVID-19 risks abate, more Americans dine out at restaurants, check in to hotels, and fill up airplanes. Those are important categories of spending in a country where consumption makes up about 70 percent of total economic activity. In the second quarter of this year, for instance, GDP grew at a very healthy annualized rate of around 6.7 percent as case rates plummeted.

And, of course, the opposite occurs during periods when the virus spikes. When the Delta variant of COVID-19 erupted, fomenting the country’s fourth major wave of the pandemic, things started moving sideways. Consumer confidence tanked, and large industries like hospitality and leisure stagnated at best. So for this quarter, we can expect growth to come in at an annualized rate of around 3 percent, a sharp slowdown from earlier this year. 

But there are reasons to be sanguine that the country’s recovery from this wave of COVID-19 may prove more durable than in the past and that we can avoid a fifth wave. And that is because more than half of the country is fully vaccinated. Getting more shots into arms will save lives and aid the recovery by reducing the size and severity of future spikes. The Delta variant has also concentrated minds: It seems to have not only persuaded more Americans to get shots on their own, but it also pushed more corporations and institutions to mandate their employees to get vaccinated. That is cause for optimism.

Filling me with less optimism is the persistent constraints the economy is operating under.

The COVID-19 pandemic has revealed how fragile many of our supply chains are. We’re now experiencing shortages of crucial parts like computer chips, which has hobbled not only the production of cars and trucks, but also comparatively smaller durable goods like home appliances. My recent experience attempting to purchase a printer — there were essentially none at my local electronics store — testifies to that. And good luck trying to find a new washing machine or dishwasher.

These supply chain constraints are rippling through the entire economy. Manufacturers in our region have reported having to curtail production because of difficulties securing raw materials. We’re also seeing low inventory of everything from shoes to backpacks to even chicken wings, which is a particularly troubling development as the NFL season is picking up. Unfortunately, there are indications that these constraints could persist for a couple of more years.

There’s another input lacking in supply as well, further constraining the economy: labor. It isn’t true, as was widely reported, that the economy only created 194,000 jobs in September. In reality, the U.S. economy has created many millions of jobs in recent months — we just can’t fill them. Indeed, job openings are at record highs, hitting nearly 10.5 million at the end of August. Simultaneously, more people are quitting their jobs, and the rate at which open positions are being filled is continuing to slow.

It seems that a combination of factors — trouble accessing childcare or eldercare, lingering fears about the virus, the rise in equities and home values spurring people to retire, and perhaps a general revaluation of life choices — is persuading a lot of Americans to stay on the sidelines even as the economy has reopened. And notably, the elimination of extra federal unemployment benefits has not — at least not yet — appeared to nudge people back into the workforce. I do expect that will change eventually and especially as other forbearance programs run out.

So, where does all of this leave us? For 2021, I would expect GDP growth to come in around 5.5 percent, which is a downward revision from before Delta took hold. Growth will then moderate to about 3.5 percent in 2022, and 2.5 percent in 2023. Inflation, meanwhile, should come in around 4 percent for 2021, though I do see upside risk here. After that, our modal forecast — that is, the average of all of our forecasts — calls for inflation of a bit over 2 percent for 2022 and right at 2 percent in 2023.

Fed Policy

In terms of monetary policy, I am in the camp that believes it will soon be time to begin slowly and methodically — frankly, boringly — taper our $120 billion in monthly purchases of Treasury bills and mortgage-backed securities. This comes down to the efficacy of these purchases as a tool.

They were necessary to keep markets functioning during the acute phase of the crisis. But to the extent that we are still dealing with a labor force issue, the problem lies on the supply side, not with demand. You can’t go into a restaurant or drive down a commercial strip without noticing a sea of “Help Wanted” signs. Asset purchases aren’t doing much — or anything — to ameliorate that.

After we taper our asset purchases, we can begin to think about raising the federal funds rate. But I wouldn’t expect any hikes to interest rates until late next year or early 2023, unless the inflation picture changes dramatically.

Conclusion

Given the strong headwinds facing the economy, it is a testament to its underlying strength that growth continues at a relatively robust pace. That is a tribute, as always, to the ingenuity and tenacity of our people, especially in the face of huge challenges.

Thank you very much again for having me. And now let’s move on to questions.

Federal Reserve Review of Monetary Policy Strategy, Tools, and Communications: Some Preliminary Views

(Speech by Governor Lael Brainard, at the Presentation of the 2019 William F. Butler Award New York Association for Business Economics, New York, New York)

It is a pleasure to be here with you. It is an honor to join the 45 outstanding economic researchers and practitioners who are past recipients of the William F. Butler Award. I want to express my deep appreciation to the New York Association for Business Economics (NYABE) and NYABE President Julia Coronado.

I will offer my preliminary views on the Federal Reserve’s review of its monetary policy strategy, tools, and communications after first touching briefly on the economic outlook. These remarks represent my own views. The framework review is ongoing and will extend into 2020, and no conclusions have been reached at this time.1

Outlook and Policy

There are good reasons to expect the economy to grow at a pace modestly above potential over the next year or so, supported by strong consumers and a healthy job market, despite persistent uncertainty about trade conflict and disappointing foreign growth. Recent data provide some reassurance that consumer spending continues to expand at a healthy pace despite some slowing in retail sales. Consumer sentiment remains solid, and the employment picture is positive. Housing seems to have turned a corner and is poised for growth following several weak quarters.

Business investment remains downbeat, restrained by weak growth abroad and trade conflict. But there is little sign so far that the softness in trade, manufacturing, and business investment is affecting consumer spending, and the effect on services has been limited.

Employment remains strong. The employment-to-population ratio for prime-age adults has moved up to its pre-recession peak, and the three-month moving average of the unemployment rate is near a 50-year low.2 Monthly job gains remain above the pace needed to absorb new entrants into the labor force despite some slowing since last year. And initial claims for unemployment insurance—a useful real-time indicator historically—remain very low despite some modest increases.

Data on inflation have come in about as I expected, on balance, in recent months. Inflation remains below the Federal Reserve’s 2 percent symmetric objective, which has been true for most of the past seven years. The price index for core personal consumption expenditures (PCE), which excludes food and energy prices and is a better indicator of future inflation than overall PCE prices, increased 1.7 percent over the 12 months through September.

Foreign growth remains subdued. While there are signs that the decline in euro-area manufacturing is stabilizing, the latest indicators on economic activity in China remain sluggish, and the news in Japan and in many emerging markets has been disappointing. Overall, it appears third-quarter foreign growth was weak, and the latest indicators point to little improvement in the fourth quarter.

More broadly, the balance of risks remains to the downside, although there has been some improvement in risk sentiment in recent weeks. The risk of a disorderly Brexit in the near future has declined significantly, and there is some hope that a U.S.China trade truce could avert additional tariffs. While risks remain, financial market indicators suggest market participants see a diminution in such risks, and probabilities of recessions from models using market data have declined.

The baseline is for continued moderate expansion, a strong labor market, and inflation moving gradually to our symmetric 2 percent objective. The Federal Open Market Committee (FOMC) has taken significant action to provide insurance against the risks associated with trade conflict and weak foreign growth against a backdrop of muted inflation. Since July, the Committee has lowered the target range for the federal funds rate by ¾ percentage point, to the current range of 1½ to 1¾ percent. It will take some time for the full effect of this accommodation to work its way through economic activity, the labor market, and inflation. I will be watching the data carefully for signs of a material change to the outlook that could prompt me to reassess the appropriate path of policy.

Review

The Federal Reserve is conducting a review of our monetary policy strategy, tools, and communications to make sure we are well positioned to advance our statutory goals of maximum employment and price stability.3 Three key features of today’s new normal call for a reassessment of our monetary policy strategy: the neutral rate is very low here and abroad, trend inflation is running below target, and the sensitivity of price inflation to resource utilization is very low.4

First, trend inflation is below target.5 Underlying trend inflation appears to be running a few tenths below the Committee’s symmetric 2 percent objective, according to various statistical filters. This raises the risk that households and businesses could come to expect inflation to run persistently below our target and change their behavior in a way that reinforces that expectation. Indeed, with inflation having fallen short of 2 percent for most of the past seven years, inflation expectations may have declined, as suggested by some survey-based measures of long-run inflation expectations and by market-based measures of inflation compensation.

Second, the sensitivity of price inflation to resource utilization is very low. This is what economists mean when they say that the Phillips curve is flat. A flat Phillips curve has the important advantage of allowing employment to continue expanding for longer without generating inflationary pressures, thereby providing greater opportunities to more people. But it also makes it harder to achieve our 2 percent inflation objective on a sustained basis when inflation expectations have drifted below 2 percent.

Third, the long-run neutral rate of interest is very low, which means that we are likely to see more frequent and prolonged episodes when the federal funds rate is stuck at its effective lower bound (ELB).6 The neutral rate is the level of the federal funds rate that would keep the economy at full employment and 2 percent inflation if no tailwinds or headwinds were buffeting the economy. A variety of forces have likely contributed to a decline in the neutral rate, including demographic trends in many large economies, some slowing in the rate of productivity growth, and increases in the demand for safe assets. When looking at the Federal Reserve’s Summary of Economic Projections (SEP), it is striking that the Committee’s median projection of the longer-run federal funds rate has moved down from 4¼ percent to 2½ percent over the past seven years.7 A similar decline can be seen among private forecasts.8 This decline means the conventional policy buffer is likely to be only about half of the 4½ to 5 percentage points by which the FOMC has typically cut the federal funds rate to counter recessionary pressures over the past five decades.

This large loss of policy space will tend to increase the frequency or length of periods when the policy rate is pinned at the ELB, unemployment is elevated, and inflation is below target.9 In turn, the experience of frequent or extended periods of low inflation at the ELB risks eroding inflation expectations and further compressing the conventional policy space. The risk is a downward spiral where conventional policy space gets compressed even further, the ELB binds even more frequently, and it becomes increasingly difficult to move inflation expectations and inflation back up to target. While consumers and businesses might see very low inflation as having benefits at the individual level, at the aggregate level, inflation that is too low can make it very challenging for monetary policy to cut the short-term nominal interest rate sufficiently to cushion the economy effectively.10

The experience of Japan and of the euro area more recently suggests that this risk is real. Indeed, the fact that Japan and the euro area are struggling with this challenging triad further complicates our task, because there are important potential spillovers from monetary policy in other major economies to our own economy through exchange rate and yield curve channels.11

In light of the likelihood of more frequent episodes at the ELB, our monetary policy review should advance two goals. First, monetary policy should achieve average inflation outcomes of 2 percent over time to re-anchor inflation expectations at our target. Second, we need to expand policy space to buffer the economy from adverse developments at the ELB.

Achieving the Inflation Target

The apparent slippage in trend inflation below our target calls for some adjustments to our monetary policy strategy and communications. In this context and as part of our review, my colleagues and I have been discussing how to better anchor inflation expectations firmly at our objective. In particular, it may be helpful to specify that policy aims to achieve inflation outcomes that average 2 percent over time or over the cycle. Given the persistent shortfall of inflation from its target over recent years, this would imply supporting inflation a bit above 2 percent for some time to compensate for the period of underperformance.

One class of strategies that has been proposed to address this issue are formal “makeup” rules that seek to compensate for past inflation deviations from target. For instance, under price-level targeting, policy seeks to stabilize the price level around a constant growth path that is consistent with the inflation objective.12 Under average inflation targeting, policy seeks to return the average of inflation to the target over some specified period.13

To be successful, formal makeup strategies require that financial market participants, households, and businesses understand in advance and believe, to some degree, that policy will compensate for past misses. I suspect policymakers would find communications to be quite challenging with rigid forms of makeup strategies, because of what have been called time-inconsistency problems. For example, if inflation has been running well below—or above—target for a sustained period, when the time arrives to maintain inflation commensurately above—or below—2 percent for the same amount of time, economic conditions will typically be inconsistent with implementing the promised action. Analysis also suggests it could take many years with a formal average inflation targeting framework to return inflation to target following an ELB episode, although this depends on difficult-to-assess modeling assumptions and the particulars of the strategy.14

Thus, while formal average inflation targeting rules have some attractive properties in theory, they could be challenging to implement in practice. I prefer a more flexible approach that would anchor inflation expectations at 2 percent by achieving inflation outcomes that average 2 percent over time or over the cycle. For instance, following five years when the public has observed inflation outcomes in the range of 1½ to 2 percent, to avoid a decline in expectations, the Committee would target inflation outcomes in a range of, say, 2 to 2½ percent for the subsequent five years to achieve inflation outcomes of 2 percent on average overall. Flexible inflation averaging could bring some of the benefits of a formal average inflation targeting rule, but it would be simpler to communicate. By committing to achieve inflation outcomes that average 2 percent over time, the Committee would make clear in advance that it would accommodate rather than offset modest upward pressures to inflation in what could be described as a process of opportunistic reflation.15

Policy at the ELB

Second, the Committee is examining what monetary policy tools are likely to be effective in providing accommodation when the federal funds rate is at the ELB.16 In my view, the review should make clear that the Committee will actively employ its full toolkit so that the ELB is not an impediment to providing accommodation in the face of significant economic disruptions.

The importance and challenge of providing accommodation when the policy rate reaches the ELB should not be understated. In my own experience on the international response to the financial crisis, I was struck that the ELB proved to be a severe impediment to the provision of policy accommodation initially. Once conventional policy reached the ELB, the long delays necessitated for policymakers in nearly every jurisdiction to develop consensus and take action on unconventional policy sapped confidence, tightened financial conditions, and weakened recovery. Economic conditions in the euro area and elsewhere suffered for longer than necessary in part because of the lengthy process of building agreement to act decisively with a broader set of tools.

Despite delays and uncertainties, the balance of evidence suggests forward guidance and balance sheet policies were effective in easing financial conditions and providing accommodation following the global financial crisis.17 Accordingly, these tools should remain part of the Committee’s toolkit. However, the quantitative asset purchase policies that were used following the crisis proved to be lumpy both to initiate at the ELB and to calibrate over the course of the recovery. This lumpiness tends to create discontinuities in the provision of accommodation that can be costly. To the extent that the public is uncertain about the conditions that might trigger asset purchases and how long the purchases would be sustained, it undercuts the efficacy of the policy. Similarly, significant frictions associated with the normalization process can arise as the end of the asset purchase program approaches.

For these reasons, I have been interested in exploring approaches that expand the space for targeting interest rates in a more continuous fashion as an extension of our conventional policy space and in a way that reinforces forward guidance on the policy rate.18 In particular, there may be advantages to an approach that caps interest rates on Treasury securities at the short-to-medium range of the maturity spectrum—yield curve caps—in tandem with forward guidance that conditions liftoff from the ELB on employment and inflation outcomes.

To be specific, once the policy rate declines to the ELB, this approach would smoothly move to capping interest rates on the short-to-medium segment of the yield curve. The yield curve ceilings would transmit additional accommodation through the longer rates that are relevant for households and businesses in a manner that is more continuous than quantitative asset purchases. Moreover, if the horizon on the interest rate caps is set so as to reinforce forward guidance on the policy rate, doing so would augment the credibility of the yield curve caps and thereby diminish concerns about an open-ended balance sheet commitment. In addition, once the targeted outcome is achieved, and the caps expire, any securities that were acquired under the program would roll off organically, unwinding the policy smoothly and predictably. This is important, as it could potentially avoid some of the tantrum dynamics that have led to premature steepening at the long end of the yield curve in several jurisdictions.

Forward guidance on the policy rate will also be important in providing accommodation at the ELB. As we saw in the United States at the end of 2015 and again toward the second half of 2016, there tends to be strong pressure to “normalize” or lift off from the ELB preemptively based on historical relationships between inflation and employment. A better alternative would have been to delay liftoff until we had achieved our targets. Indeed, recent research suggests that forward guidance that commits to delay the liftoff from the ELB until full employment and 2 percent inflation have been achieved on a sustained basis—say over the course of a year—could improve performance on our dual-mandate goals.19

To reinforce this commitment, the forward guidance on the policy rate could be implemented in tandem with yield curve caps. For example, as the federal funds rate approaches the ELB, the Committee could commit to refrain from lifting off the ELB until full employment and 2 percent inflation are sustained for a year. Based on its assessment of how long this is likely take, the Committee would then commit to capping rates out the yield curve for a period consistent with the expected horizon of the outcome-based forward guidance. If the outlook shifts materially, the Committee could reassess how long it will take to get inflation back to 2 percent and adjust policy accordingly. One benefit of this approach is that the forward guidance and the yield curve ceilings would reinforce each other.

The combination of a commitment to condition liftoff on the sustained achievement of our employment and inflation objectives with yield curve caps targeted at the same horizon has the potential to work well in many circumstances. For very severe recessions, such as the financial crisis, such an approach could be augmented with purchases of 10-year Treasury securities to provide further accommodation at the long end of the yield curve. Presumably, the requisite scale of such purchases—when combined with medium-term yield curve ceilings and forward guidance on the policy rate—would be relatively smaller than if the longer-term asset purchases were used alone.

Monetary Policy and Financial Stability

Before closing, it is important to recall another important lesson of the financial crisis: The stability of the financial system is important to the achievement of the statutory goals of full employment and 2 percent inflation. In that regard, the changes in the macroeconomic environment that underlie our monetary policy review may have some implications for financial stability. Historically, when the Phillips curve was steeper, inflation tended to rise as the economy heated up, which prompted the Federal Reserve to raise interest rates. In turn, the interest rate increases would have the effect of tightening financial conditions more broadly. With a flat Phillips curve, inflation does not rise as much as resource utilization tightens, and interest rates are less likely to rise to restrictive levels. The resulting lower-for-longer interest rates, along with sustained high rates of resource utilization, are conducive to increasing risk appetite, which could prompt reach-for-yield behavior and incentives to take on additional debt, leading to financial imbalances as an expansion extends.

To the extent that the combination of a low neutral rate, a flat Phillips curve, and low underlying inflation may lead financial stability risks to become more tightly linked to the business cycle, it would be preferable to use tools other than tightening monetary policy to temper the financial cycle. In particular, active use of macroprudential tools such as the countercyclical buffer is vital to enable monetary policy to stay focused on achieving maximum employment and average inflation of 2 percent on a sustained basis.

Conclusion

The Federal Reserve’s commitment to adapt our monetary policy strategy to changing circumstances has enabled us to support the U.S. economy throughout the expansion, which is now in its 11th year. In light of the decline in the neutral rate, low trend inflation, and low sensitivity of inflation to slack as well as the consequent greater frequency of the policy rate being at the effective lower bound, this is an important time to review our monetary policy strategy, tools, and communications in order to improve the achievement of our statutory goals. I have offered some preliminary thoughts on how we could bolster inflation expectations by achieving inflation outcomes of 2 percent on average over time and, when policy is constrained by the ELB, how we could combine forward guidance on the policy rate with caps on the short-to-medium segment of the yield curve to buffer the economy against adverse developments.


  1. I am grateful to Ivan Vidangos of the Federal Reserve Board for assistance in preparing this text. These remarks represent my own views, which do not necessarily represent those of the Federal Reserve Board or the Federal Open Market Committee. (return to text)
  2. Claudia Sahm shows that a ½ percentage point increase in the three-month moving average of the unemployment rate relative to the previous year’s low is a good real-time recession indicator. See Claudia Sahm (2019), “Direct Stimulus Payments to Individuals” [archived PDF], Policy Proposal, The Hamilton Project at the Brookings Institution (Washington: THP, May 16). (return to text)
  3. Information about the review of monetary policy strategy, tools, and communications is available on the Board’s website. Also see Richard H. Clarida (2019), “The Federal Reserve’s Review of Its Monetary Policy Strategy, Tools, and Communication Practices” [archived PDF], speech delivered at the 2019 U.S. Monetary Policy Forum, sponsored by the Initiative on Global Markets at the University of Chicago Booth School of Business, New York, February 22; and Jerome H. Powell (2019), “Monetary Policy: Normalization and the Road Ahead” [archived PDF] speech delivered at the 2019 SIEPR Economic Summit, Stanford Institute of Economic Policy Research, Stanford, Calif., March 8. (return to text)
  4. See Lael Brainard (2016), “The ‘New Normal’ and What It Means for Monetary Policy” [archived PDF] speech delivered at the Chicago Council on Global Affairs, Chicago, September 12. (return to text)
  5. See Lael Brainard (2017), “Understanding the Disconnect between Employment and Inflation with a Low Neutral Rate” [archived PDF], speech delivered at the Economic Club of New York, September 5; and James H. Stock and Mark W. Watson (2007), “Why Has U.S. Inflation Become Harder to Forecast?” [archived PDF], Journal of Money, Credit and Banking, vol. 39 (s1, February), pp. 3–33. (return to text)
  6. See Lael Brainard (2015), “Normalizing Monetary Policy When the Neutral Interest Rate Is Low” [archived PDF] speech delivered at the Stanford Institute for Economic Policy Research, Stanford, Calif., December 1. (return to text)
  7. The projection materials for the Federal Reserve’s SEP are available on the Board’s website. (return to text)
  8. For example, the Blue Chip Consensus long-run projection for the three-month Treasury bill has declined from 3.6 percent in October 2012 to 2.4 percent in October 2019. See Wolters Kluwer (2019), Blue Chip Economic Indicators, vol. 44 (October 10); and Wolters Kluwer (2012), Blue Chip Economic Indicators, vol. 37 (October 10). (return to text)
  9. See Michael Kiley and John Roberts (2017), “Monetary Policy in a Low Interest Rate World” [archived PDF], Brookings Papers on Economic Activity, Spring, pp. 317–72; Eric Swanson (2018), “The Federal Reserve Is Not Very Constrained by the Lower Bound on Nominal Interest Rates” [archived PDF] NBER Working Paper Series 25123 (Cambridge, Mass.: National Bureau of Economic Research, October); and Hess Chung, Etienne Gagnon, Taisuke Nakata, Matthias Paustian, Bernd Schlusche, James Trevino, Diego Vilán, and Wei Zheng (2019), “Monetary Policy Options at the Effective Lower Bound: Assessing the Federal Reserve’s Current Policy Toolkit” [archived PDF], Finance and Economics Discussion Series 2019-003 (Washington: Board of Governors of the Federal Reserve System, January). (return to text)
  10. The important observation that some consumers and businesses see low inflation as having benefits emerged from listening to a diverse range of perspectives, including representatives of consumer, labor, business, community, and other groups during the Fed Listens events; for details, see this page. (return to text)
  11. See Lael Brainard (2017), “Cross-Border Spillovers of Balance Sheet Normalization” [archived PDF] speech delivered at the National Bureau of Economic Research’s Monetary Economics Summer Institute, Cambridge, Mass., July 13. (return to text)
  12. See, for example, James Bullard (2018), “A Primer on Price Level Targeting in the U.S.” [archived PDF], a presentation before the CFA Society of St. Louis, St. Louis, Mo., January 10. (return to text)
  13. See, for example, Lars Svensson (2019), “Monetary Policy Strategies for the Federal Reserve” [archived PDF] presented at “Conference on Monetary Policy Strategy, Tools and Communication Practices,” sponsored by the Federal Reserve Bank of Chicago, Chicago, June 5. (return to text)
  14. See Board of Governors of the Federal Reserve System (2019), “Minutes of the Federal Open Market Committee, September 17–18, 2019,” press release, October 9; and David Reifschneider and David Wilcox (2019), “Average Inflation Targeting Would Be a Weak Tool for the Fed to Deal with Recession and Chronic Low Inflation” [archived PDF] Policy Brief PB19-16 (Washington: Peterson Institute for International Economics, November). (return to text)
  15. See Janice C. Eberly, James H. Stock, and Jonathan H. Wright (2019), “The Federal Reserve’s Current Framework for Monetary Policy: A Review and Assessment” [archived PDF] paper presented at “Conference on Monetary Policy Strategy, Tools and Communication Practices,” sponsored by the Federal Reserve Bank of Chicago, Chicago, June 4. (return to text)
  16. See Board of Governors of the Federal Reserve System (2019), “Minutes of the Federal Open Market Committee, July 31–August 1, 2018” [archived PDF] press release, August 1; and Board of Governors (2019), “Minutes of the Federal Open Market Committee, October 29–30, 2019” [archived PDF] press release, October 30. (return to text)
  17. For details on purchases of securities by the Federal Reserve, see this page. For a discussion of forward guidance, see this page. See, for example, Simon Gilchrist and Egon Zakrajšek (2013), “The Impact of the Federal Reserve’s Large-Scale Asset Purchase Programs on Corporate Credit Risk,” Journal of Money, Credit and Banking, vol. 45, (s2, December), pp. 29–57; Simon Gilchrist, David López-Salido, and Egon Zakrajšek (2015), “Monetary Policy and Real Borrowing Costs at the Zero Lower Bound,” American Economic Journal: Macroeconomics, vol. 7 (January), pp. 77–109; Jing Cynthia Wu and Fan Dora Xia (2016), “Measuring the Macroeconomic Impact of Monetary Policy at the Zero Lower Bound,” Journal of Money, Credit and Banking, vol. 48 (March–April), pp. 253–91; and Stefania D’Amico and Iryna Kaminska (2019), “Credit Easing versus Quantitative Easing: Evidence from Corporate and Government Bond Purchase Programs” [archived PDF], Bank of England Staff Working Paper Series 825 (London: Bank of England, September). (return to text)
  18. See Board of Governors of the Federal Reserve System (2010), “Strategies for Targeting Interest Rates Out the Yield Curve,” memorandum to the Federal Open Market Committee, October 13, available at this page; and Ben Bernanke (2016), “What Tools Does The Fed Have Left? Part 2: Targeting Longer-Term Interest Rates” [archived PDF] blog post, Brookings Institution, March 24. (return to text)
  19. See Ben Bernanke, Michael Kiley, and John Roberts (2019), “Monetary Policy Strategies for a Low-Rate Environment” [archived PDF], Finance and Economics Discussion Series 2019-009 (Washington: Board of Governors of the Federal Reserve System) and Chung and others, “Monetary Policy Options at the Effective Lower Bound,” in note 9. (return to text)

Essay 84: World Watching: U.S.-China Tariffs

(from the PIIE Insider)

News and Analysis from the Peterson Institute for International Economics
November 13, 2019

They Saved the Worst for Last: Why Trump’s Impending December Tariffs on China Should Be Rolled Back

The terms and deadlines of President Donald Trump’s trade war with China are hard to follow, but one thing is clear: American consumers and businesses should welcome a rollback of impending final rounds of China tariffs as part of a possible “phase 1” deal to be announced later in November, say Mary E. Lovely and Yang Liang. Washington has acted against China to punish it for preventing US access to the Chinese market and for violating US intellectual property rights.  Beijing is reportedly demanding that impending December tariffs be dropped before they sign any deal. Trump says he hasn’t decided how many tariffs might be lifted.

Key Takeaways

Read the full story at PIIE [archived PDF].