Why I am baffled by Janet Yellen’s bafflement
The encouraging news last month from Janet Yellen, chairman of the US Federal Reserve, was that she seems to have relented on plans to hike interest rates four times in 2016, in recognition of the still fragile state of the global economy. Markets worldwide have celebrated. Spirits have been buoyed.
The worrying news, as she briefed the Economic Club of New York, was that she still claims to be “baffled” by the persistent absence of any inflation that would suggest the economy is recovering. Why so baffled? Isn’t the evidence in plain sight? I can see at least six good reasons why gloom prevails:
•First, and perhaps most important, there is widespread scepticism about the Fed’s “evidence” of recovery. Look across the world, and the evidence of distress is all around. Global trade has contracted in value terms for the first time in most of our memories. Governments are deeply in debt, and are cutting government services and state benefits. Large companies are still laying off large numbers of people.
•Yes, unemployment has in formal terms fallen to the lowest levels in a decade. But that employment is less secure, and less well paid – and large numbers have also simply given up searching for work. If your new job is insecure, pays less, and lacks good health-care benefits, then the inclination to save rather than spend must be very strong. We are unlikely to see any surge in consumer spending until these uncertainties have evaporated – and there is no sign of evaporation yet. On the contrary, job insecurity seems likely to be a reality for the future; and for the first time in many peoples’ lifetimes, wage decreases seem as possible as wage increases as working lives progress.
•Third, those sitting on asset wealth – a nice house, or apartment or a bunch of shares – may be looking at values at high levels, but this is providing scant confidence: there is great uncertainty about whether values will stay so high. And of course, those who can’t afford homes at present stratospheric prices are depressed by the challenge of ever being able to save enough for a home. Once interest rates begin to return to “normal” levels as quantitative easing (QE) policies are unravelled, mortgage costs are likely to soar just as property values tumble. Once again, such asset wealth is not providing any comfort over future security. Caution prevails and the incentive to go out shopping remains weak.
•Health-care and education costs have been rising fast, against trends in other areas of our economies where prices have been stable or weak – and these costs weigh heavily on many families. Add in concerns about saving for old age, and the medical costs linked with that, and the incentive to save rather than spend remains very strong.
•A number of often-unnoticed reasons for falling prices have over the past decade brought benefits that have defused dangers of inflation, but have done little to buoy consumer spirits: China’s “inflationary gift” – the fact that for perhaps two decades the creation of global production chains built around cheap assembly in China has enabled us to buy a wide range of consumer products cheaper and cheaper year by the year – has brought little comfort or confidence because of the “offshoring” of jobs, and the downward pressure on local wage rates. And the “technological innovation gift”, which has given our smartphones, high-definition TVs, etc, more power and sophistication by the year at steadily falling prices has paradoxically discouraged consumer spending: why buy a new smartphone today, when the one that will be launched in six months time will be twice as powerful and 20 per cent cheaper?
•Lower oil prices ought to have translated quickly into lower fuel prices and lower costs for things like air travel. But so far, little stimulus has been apparent. This is in part because it takes time for these lower prices to feed through, but is also in part because for many drivers around the world, most of the cost of a litre or gallon of fuel is made up of taxes, fuel processing costs and delivery costs. Even where drivers have seen significant relief from falling fuel prices, the precautionary pressure to save or reduce debts has so far suppressed most peoples’ urge to spend.
For an ordinary consumer in the street, these negative forces that have suppressed consumer spending and continue to do so are screamingly obvious. But behind Yellen’s bafflement is an awkward reality: she, and the armies of economic advisers that work around the Fed and other big economic institutions spend their time poring over econometric models and oceans of monthly statistical data, rather than going out onto the street and smelling the air.
It seems the Fed relies on two indicators in particular: a University of Michigan survey of consumers, and the US Treasury’s Inflation-Protected Securities market, or “Tips”. In normal times, reliance on such statistical devices might work well, but who is to say they are emitting accurate signals in these very abnormal times? As one commentator noted last week: “Perhaps the data on inflation expectations are distorted.”
Get out on the street, and the reality most people are feeling is much more dispiriting than Yellen’s statisticians are telling her. So instead of relying on data modelling, she and her counterparts around the world ought to be sending more people out onto the streets to “smell the air”. As one anthropologist put it: “What we need is not just economic analysis but on-the-ground ethnographic analysis of how consumer perceptions of prices actually operate.”
I am an anthropologist by training, and I would wholly endorse that view. I don’t trust GDP numbers, or producer price indices, and would much prefer a combination of common sense and good conversations with people out in the real world. Economists and policymakers may prefer their models, but from my point of view, therein lies bafflement.
David Dodwell is Executive Director of the Hong Kong-Apec Trade Policy Group