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SBOI, Inflation and the Fed - February 12, 2019

“Expectations about the future are shaky”

Today, the NFIB released its Small Business Optimism Index and while the press has highlighted the relative weakness, the data is not all bad. True, the headline reading was the lowest of Trump’s presidency, and both sales growth and business expectations weakened, but this softening came while the Uncertainty Index jumped seven points (to the fifth highest reading on record). This is not a coincidence according to Juanita Duggan of the NFIB, “Business operations are still very strong... and while they are continuing to create jobs and increase compensation at a frenetic pace, the political climate is affecting how they view the future”. Bill Dunkelberg, NFIB Economist, more directly blamed Washington, saying the government shutdown and political gridlock have elevated “the level of uncertainty, which is damaging economic activity”.

Despite the uncertainty, “Hiring, hiring plans, and job openings remained strong”. Compensation plans hit the second highest level on record and it remains difficult for employers to find qualified workers. These survey results affirmed recent “outsized job numbers”. Today’s JOLTS data showed 7.3 million job openings, the highest in the history of the data series. However, in the face of labor tightness, the NFIB notes, “In no industry group did the percent raising prices exceed the percent raising worker compensation, good news for inflation watchers”. While combining anecdotes doesn’t create evidence, there are reasons to believe pressures are rising. Amazon’s Whole Foods is raising prices due to supplier cost push and Walmart is raising wages for truck drivers. Tomorrow’s CPI will be one to watch.

 “Allowing inflation to rise temporarily”

Beyond the “good news for inflation watchers”, it turns out that inflation may not even be something to fret over! 2016 research from Vasco Curdia, whose recent research we profiled last week, found that “allowing inflation to temporarily rise above the Fed’s 2% target” “would eliminate the remaining economic slack... substantially faster than if inflation remained below its target”. In “Is There a Case for Inflation Overshooting?”, Curdia describes how a different approach to rate hikes, called “optimal control”, would be beneficial and “speed up the ongoing economic recovery”. This isn’t a new idea, and Fed watchers will recognize it from past talks given by Janet Yellen, including her 2012 speech on Central Bank communication.

Adam Ozimek and Michael Ferlez of Moody’s provide a more complex analysis of the Fed’s path in “The Fed’s Mistake”. Their analysis makes the distinction that the Fed made an ex-post mistake, “that subsequent data have revealed that the Fed raised rates too fast” (emphasis our own), based on inaccurate estimates. While on the technical side, Ozimek and Ferlez do an excellent job synthesizing how Fed estimates, forecasts, and actions interplay. The paper is a worthwhile read for Dot Watchers and the simply curious alike.