December 17, 2017
Zachary Karabell, the head of global strategies at Envestnet, got the story badly wrong in a Post Outlook section piece arguing that the Fed’s model of inflation is wrong. The piece highlights the relatively rapid growth in the last two quarters and argues that this should be leading to inflation. That is not what the Fed’s model would predict.
In the Fed’s model, the change in the rate of inflation is tied to the level of unemployment. While the unemployment rate is at a level where the model predicts rising inflation, the rate of GDP growth is largely besides the point. The economy has had much more rapid GDP growth at earlier points in the recovery. For example, growth averaged 4.9 percent in the third and fourth quarters of 2014. It averaged 2.9 percent in the second and third quarters of 2015.
The question is primarily one of how rapidly productivity can grow. The labor market is getting tighter, although with the employment-to-population (EPOP) ratio of prime-age (ages 25 to 54) still below pre-recession levels and well below 2000 levels, it is likely that we still have some ways to go before reaching full employment. Once that point is reached, the economy will only be able to grow at the rate of labor force growth determined by demographics (around 0.5–0.7 percent) plus the rate of productivity growth.
Productivity growth had been averaging less than 0.7 percent annually from 2012 to 2017, and most projections had assumed slow growth would continue. However, it grew at more than a 3.0 percent annual rate in the third quarter and seems on track to again grow at a rate above 2.0 percent in the fourth quarter. If we can sustain a faster rate of productivity growth, the economy will be able to sustain a faster rate of GDP growth even when the labor market is fully employed.
Karabell’s discussion of technology and automation is also seriously confused. He tells readers:
“The McKinsey Global Institute has made waves with its bold predictions of an increasingly robotic future that will make many jobs obsolete. And it doesn’t take an elite consultancy to notice that technology is creating massive deflation of goods and services: A smartphone that retails for less than $1,000 does the work of equipment that cost 10 times that a decade ago, and food and clothing (once a considerable portion of a typical family’s budget) continue to decline in price. What’s more, the disparity between skilled workers, whose wages are rising, and workers with fewer or outdated skills means there can be inflation in urban hubs like New York and San Francisco and deflation everywhere else, which would make broad-brush Fed policy into a bazooka, helping and harming simultaneously.”
The Mckinsey Global Institute predictions are hugely out of line with virtually all professional forecasters, who have assumed that the trend of slow growth would continue and they are demonstrably out of line with the data to date. In other words, we know that we haven’t seen a massive impact of technology on productivity in the last decade, contrary to what Karabell claims. There are always products that have seen rapid declines in price, so the example of the smartphone is not new. The question is how large a share of the economy this represents. The data from the Bureau of Labor Statistics on productivity indicate it’s a small share of the economy. If Karabell has evidence that shows otherwise, he should share it with readers.
It is also worth noting that the big gains in employment over the last two years have been for less-educated workers, those with a high school degree or less. The EPOP ratio for college grads has not increased over the last year, while the EPOP for workers with just a high school degree and those with less than a high school degree have risen by 0.1 percentage points and 1.4 percentage points, respectively.
Comments