Fed Confidence in Transitory Inflation Hinges on Low Wage Gains
Ryan Ferry, a carpenter with Hazelwood Homes, measures vinyl siding outside a home under construction in Geneseo, Illinois. Despite rising consumer prices, workers' purchasing power is shrinking and officials at the Federal Reserve see no evidence that they expect a pay raise. Photographer: Daniel Acker/Bloomberg via Getty Images
April 26 (Bloomberg) -- Richard Koo, chief economist at Nomura Research Institute, talks about Federal Reserve monetary policy. Koo, speaking with Deirdre Bolton on Bloomberg Television's "InsideTrack," also discusses the outlook for the U.S. economy and banking regulation. (Source: Bloomberg)
Fed Vice Chairman Janet Yellen. Photographer: Matthew Staver/Bloomberg
Brady Miller is paying more for vinyl siding for his construction business and for groceries to feed his family. He can’t charge customers more, showing why some Federal Reserve officials say inflation will ease.
“We don’t spend money on anything, we don’t take vacations, and I am not saving money right now,” Miller, 36, says. He has told his wife that he is going to drive their 2005 Dodge Caravan “until that thing falls apart.”
The Mossville, Illinois, homebuilder also hasn’t given his crew of two a raise in two years and says they shouldn’t expect one soon. Their predicament illustrates the downside of what Fed Vice Chairman Janet Yellen calls “transitory” inflation: Household purchasing power is shrinking because wages and salaries aren’t keeping pace with food and energy prices.
Researchers at the Federal Reserve Bank of New York are also finding no evidence that higher prices are boosting expectations for wage increases, suggesting underlying inflation and consumer spending will remain low. That’s why officials led by Fed Chairman Ben S. Bernanke will be in no hurry to withdraw record stimulus after completing a $600 billion bond-purchase program in June, said Michael Feroli, chief U.S. economist at JP Morgan Securities LLC.
“It’s tough,” Feroli said. “Consumers will have to reduce real spending” if they don’t draw down savings or take on more debt. He said the Fed will probably keep its balance sheet constant by reinvesting maturing bond proceeds for several weeks after it stops outright purchases. It may then allow the record $2.69 trillion balance sheet to “passively decline” in the second half of this year as investments mature, said Feroli.
Stay Near Zero
Feroli is also among analysts who say the Federal Open Market Committee, which concludes a two-day meeting tomorrow, is likely to repeat that the key interest rate will stay near zero for “an extended period.”
Economists at New York-based JPMorgan Chase & Co. cut their estimate for U.S. growth in the first quarter to a 1.4 percent annual rate from 2.5 percent. That would be less than half the fourth quarter’s 3.1 percent pace. One reason for the slowdown: consumer dollars after inflation buy fewer goods and services.
The consumer price index rose 2.7 percent for the year that ended in March, the fastest 12-month pace since December 2009. Average hourly earnings, adjusted for inflation, fell 1 percent during the same period.
“If the labor market were tight, workers could say, ‘I am getting squeezed, can I get a raise?’” said Julia Coronado, chief economist for North America at BNP Paribas in New York. That’s not an option with 13.5 million unemployed Americans competing for work and a jobless rate of 8.8 percent, she said.
Political Unrest
Inflation is accelerating as political unrest in the Middle East drives up the price of crude oil, and rising demand in China and other emerging markets -- coupled with droughts in grain-exporters such as Russia -- pushes up food prices. The average price for unleaded gasoline stands at $3.86 per gallon, according to the American Automobile Association, a 35 percent increase from a year ago.
The breakeven rate for two-year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable maturity Treasuries, has risen to 2.57 percentage points in New York from 2.48 percentage points at the end of March.
Petroleum-based homebuilding materials like shingles and felt paper “have consistently gone up” in price, Miller said. “I have had to lower my margins just to keep busy” in the face of tighter competition during the recent economic downturn, he said. “I am getting my ass kicked.”
Excluding food and energy, which tend to be volatile, consumer prices rose 1.2 percent in March from a year earlier. A gauge watched by Fed policy makers, which tracks prices tied to consumer spending, rose by 0.9 percent. That compares with the Fed’s long-term goal of about 2 percent inflation.
Recent ‘Shocks’
“Recent commodity price shocks are likely to have only a transitory effect on inflation,” Yellen said in an April 11 speech to the Economic Club of New York. “With resource slack likely to diminish only gradually over the next few years, it seems reasonable to anticipate that underlying inflation will remain subdued for some time,” she said.
Yellen said the Fed’s current “accommodative stance” is still appropriate because “unemployment remains elevated” and “longer-run inflation expectations remain well anchored.”
How households form expectations for future inflation is the subject of research by New York Fed economists who teamed up with behavioral psychologists from Carnegie Mellon University in Pittsburgh and researchers from RAND Corp., the Santa Monica, California-based research firm.
Median Wage Growth
Their survey of about 400 people in February showed that year-ahead median wage growth expectations remained below 1 percent, where they have been since February 2009.
“While this is a troubling sign for wage earners’ incomes, it suggests that concerns about wages exerting second-order effects on inflation are not founded at present,” New York Fed economist Giorgio Topa and colleagues wrote in an April 18 blog.
That hasn’t stopped some companies from passing rising costs on to consumers. Ford Motor Co. (F), the second-largest U.S. automaker, raised prices by $117, or 0.4 percent, per vehicle this month because of higher costs for raw materials such as steel.
Hartford, Connecticut-based United Technologies Corp. (UTX), the world’s largest maker of air conditioners, increased prices about 2 percent to 6 percent in its Carrier residential division in February to offset higher prices for copper.
“Those prices seem to be sticking,” chief financial officer Gregory Hayes told investors on an April 20 conference call.
Inflation Tolerance
How many companies follow suit depends in part on whether consumers and executives believe the Fed will allow inflation to continue.
One measure of such expectations, the Thomson Reuters/University of Michigan Surveys of Consumers, showed respondents in April expected prices to rise 4.6 percent over a year, the same as in March and the highest reading since August 2008.
“The Michigan measure appears to reflect expectations of food and gasoline price increases to a much larger extent than is suggested by their share in household expenditures and in measures of overall inflation such as the consumer price index,” Topa and colleagues wrote in their April 18 blog. Food and gasoline account for about one fifth of the CPI.
Richard Curtin, Director of Reuters/University of Michigan Surveys of Consumers, defended its results.
‘Alleged Bias’
“Despite the alleged bias, this inflation expectation series has been repeatedly found to forecast the year ahead inflation rate with an accuracy on par with professional economists,” Curtin said in an e-mail.
The University of Michigan’s survey asks about “prices in general.” In a separate survey, New York Fed-RAND researchers asked about the outlook for the “rate of inflation.”
Respondents in the New York Fed-RAND survey “tended to think less about a few salient price changes specific to their own experiences and more about price changes across a broader set of items,” Simon Potter, co-head of the New York Fed’s research and statistics group, said in a March 30 speech.
New York Fed-RAND surveys also show that when households in February were asked about year-ahead changes for “prices in general,” the median response was 3.8 percent, up from 2.4 percent in September, a gain of more than a percentage point.
By contrast, the “rate of inflation” question produced a median expectation of 3.2 percent inflation over the next year compared with 2.5 percent in September.
Validate Prices
Miller, the Illinois homebuilder, said people in his community of about 186,000 in Peoria County, many of whom work in manufacturing, probably won’t increase spending and validate higher prices.
Caterpillar Inc. (CAT), for example, which has about 16,000 employees in the Peoria region, reached its corporate goals for incentive pay in 2010, and qualifying employees received checks in March. There was no incentive pay in 2009.
Caterpillar employees he knows “are not going out and spending that money,” Miller said. “When they get that bonus they are either socking it away for the next time, or they are paying down debt.”
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