Macro Roundup

The US labor market is very tight. Not only is unemployment very low, but vacancies are exceptionally high.As shown in figure 1, in the unemployment/ vacancy space, call it the Beveridge space, the most recent points available at the time of writing (the red dot represents April 2022, the latest point for which we had data on vacancies at the time of writing) are outliers, very high and very much to the left. Our interpretation is that one can think of any point in the Beveridge space as the intersection of two relations: one focusing on the effect of aggregate activity, the other on the effects of reallocation and matching. We conclude that the current point is the result of both strong aggregate activity and more difficult matching, reflecting both higher reallocation and a lower matching efficiency. This has two important implications: The first is that more difficult matching implies, ceteris paribus, that the natural rate of unemployment has increased. We estimate that, leaving aside other reasons why it may have increased, this implies an increase in the natural rate of about 1.3 percentage points from its pre-COVID level, and by implication an even tighter labor market than suggested by just looking at the current unemployment rate. The second implication is that, contrary to the hopes of the Fed officials, it is highly unlikely that the decrease in the vacancy rate can be achieved without a substantial increase in the unemployment rate. Theory suggests that this would require a strong improvement in matching, through either a slowdown in reallocation or an improvement in matching efficiency, on which the Fed has no control and which we see no reason to expect—the empirical evidence indicates that it has never happened before. Fighting inflation will require a decrease in vacancies and an increase in unemployment. There is no magic tool.Turning to the empirical evidence, looking at the historical relation between job vacancies and unemployment going back to the 1950s and analyzing the trajectory of unemployment after vacancies come down from a peak, there has never been a historical example where the job vacancy rate came down in a substantial way without a significant increase in unemployment. To look at the evidence over a long time period, one can extend the JOLTS vacancy series back to the 1950s using data constructed by Regis Barnichon (2010), who makes use of the Help-Wanted Index published by the Conference Board to create a vacancy rate series from 1951 to 2000. This is done in figure 5.Figure 5 plots separately each vacancy rate peak plus and minus eight quarters to visualize the movement in the unemployment rate after each vacancy peak between 1951 and 2019. The eight quarters before a peak are shown in blue and the eight quarters after a peak are shown in orange (this is related to Diamond and Şahin (2015), who instead look at movements in unemployment and vacancies after each business cycle trough). The figure shows that in every historical example, the unemployment rate rose substantially in the eight quarters after the vacancy rate reached its maximum. Table 1 presents the same evidence in quantitative terms. It computes for each episode the change in the vacancy rate and the unemployment rate from the month of the peak vacancy rate, and the ratio of the change in the unemployment rate over the change in the vacancy rate, over the next 6 months, 12 months, and 24 months after the peak.The data in table 1 yield two conclusions. The first is the presence of Beveridge loops. In each episode (with the exception of November 1987), the increase in the unemployment rate relative to the decrease in the vacancy rate increased over time. Put another way, the vacancy rate declined initially faster than the unemployment rate increased. The average of the ratio of the change in unemployment to the change in the vacancy rate was −0.4 after 6 months, and increased to −0.7 after 12 months and −1.5after 24 months. The second, and most important, is that in all episodes when the vacancy rate came down in a meaningful way, the unemployment rate increased substantially. There was no free lunch, and there is no reason to expect one today.

Olivier Blanchard, Alex Domash, and Lawrence Summers, "Bad News for the Fed from the Beveridge Space,"Peterson Institute For International Economics, July 2022, https://www.piie.com/sites/default/files/documents/pb22-7.pdf

Former Obama economic adviser and now Harvard professor Jason Furman was early among Democratic economists in warning of the inflation threat, but now says he regrets not making his case more forcefully. Mr. Furman makes his interesting comments in an interview with Noam Dworman of New York City’s Comedy Cellar. Viewers wondering why the famous economist would choose such a forum for his observations learn that he grew up around the corner from the legendary club. Mr. Furman says: “I think on this one, most of the academic economists who do research in economics that I talked to actually agreed that it was too large, agreed that it would cause inflation, but most of them just do their research. Might be afraid of rocking the boat. Might not have a way to get their ideas out there. So I think it was less of a minority opinion than you might think but certainly there weren’t a lot of people expressing it last year.”

James Freeman, "Bernie Sanders and ‘Doomerism’,"Wall Street Journal, July 22, 2022, https://www.wsj.com/articles/bernie-sanders-and-doomerism-11658525804

Bernie Sanders and ‘Doomerism’

“We can’t give in to doomerism,” tweets Sen. Bernie Sanders (socialist, Vt.). It seems to be a refreshing new message from a man who’s been claiming for more than half a century that America is in crisis and in need of revolutionary change. But the meaning of the new Sanders declaration is counterintuitive. He’s actually trying to console supporters who fear that what’s really doomed is his political agenda. In the course of comforting the afflicted, he makes a revealing point about the U.S. economy.

For the Vermont socialist to go on the record now against doom-saying is especially striking because since the dawn of the Biden era Mr. Sanders has been issuing Washington’s gloomiest economic reports. In order to justify the massive expansion of government that he and Joe Biden hoped to move through the Senate, Mr. Sanders stubbornly maintained that the economy was in a shambles at the end of 2020. This column noted at the time: “... Mr. Sanders said, “The working class of this country today faces more economic desperation than at any time since the Great Depression of the 1930s.” Unemployment in the 1930s soared to around 25%. Today it’s below 7%, clocking in at 6.7% in November. The U.S. unemployment rate has reached this level or higher at some point in every decade since the 1930s, including for the entire Obama-Biden first term.”

Now flash forward to this week and to the senator’s effort to soothe the sad Sandernistas. To be sure, some of them seem to be taking the failure of much of his agenda pretty hard. In a video accompanying his tweet, Mr. Sanders reads a few notes from supporters and then responds to their suffering. He begins with the following message:I have found it hard to avoid doomerism. How do I avoid losing all hope?
Another fan inquires of the senator:Is it ever going to get any better? Should I maintain any will to live?

Mr. Sanders appears somewhat shaken by the latter comment and understandably notes that it “makes me nervous” and then affirms that yes, his followers should maintain the will to live. The senator then correctly notes that America has faced tough times before and offers some useful perspective:You know, in the 1930s, during the Depression, 25% of people in this country were unemployed.
It’s probably as close as Mr. Sanders will ever get to acknowledging that his claims about the rebounding economy at the end of 2020 were wildly off target—and so too was the Biden-Sanders program of hitting the accelerator on federal spending.

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Unfortunately it seems that too few academic economists were willing to enter the public debate and explain why the last thing the growing economy needed was the $1.9 trillion “rescue plan” that Mr. Sanders voted for and that President Biden signed into law in March 2021. Americans have been living with the inflation consequences ever since.

Former Obama economic adviser and now Harvard professor Jason Furman was early among Democratic economists in warning of the inflation threat, but now says he regrets not making his case more forcefully. Mr. Furman makes his interesting comments in an interview with Noam Dworman of New York City’s Comedy Cellar. Viewers wondering why the famous economist would choose such a forum for his observations learn that he grew up around the corner from the legendary club. Mr. Furman says:I think on this one, most of the academic economists who do research in economics that I talked to actually agreed that it was too large, agreed that it would cause inflation, but most of them just do their research. Might be afraid of rocking the boat. Might not have a way to get their ideas out there. So I think it was less of a minority opinion than you might think but certainly there weren’t a lot of people expressing it last year.

What would we do without experts? In response to Mr. Dworman’s observation that many credentialed experts across all fields have followed political agendas and therefore lost credibility among the public, Mr. Furman says:Yeah, I think we’ve made it harder to have opinions and put them out there. You know, something like the school closures last year. An economist I know, Emily Oster--she did research and writing on it--that the schools shouldn’t be closed. And the feedback she got was vicious and horrible and just incessant. She left Twitter. She continued communicating in other formats. Now she’s 100% vindicated. It was a disaster, just a disaster for children. And, you know, people weren’t speaking up.

Recent decades are characterized by large imbalances in the U.S. net foreign asset (NFA) position. Adopting a portfolio-based approach, we estimate demand curves for international debt and equity markets at the country level, and use the estimated demand system to quantitatively attribute the long-run deterioration of the U.S. NFA position to three forces: the global savings glut, changes in official holdings, and changes in investor demand. We find that standard narratives of the global savings glut and change official holdings contribute to the global imbalances by decreasing the U.S. NFA position from −10% to −94% of 2002 GDP, whereas investor’s demand shifts reverse this trend by 62% of 2002 GDP. Furthermore, we quantify how changes in U.S. NFA position were driven by different forces across asset classes and between assets versus liabilities. Our decomposition shows that underlying a seemingly simple trend in global imbalances lie opposing forces related to investor savings behavior, official holdings, and investor demand shifts. First, to capture the effect of the savings glut, which represents savings in excess of domestic investment opportunities, we restore the actual time series of investors’ net savings and asset issuances. Second, on top of the first counterfactual, we restore central banks’ official holdings to capture the effect of central bank purchases in different countries. Third, we restore the actual time series of the investors’ demand shifts to capture the effect of changes in the relative desirabilities of the assets. After we complete all three steps, by construction, the equilibrium asset prices and portfolio allocations are also restored to the actual values in the data. We report three key findings. First, we find that the savings glut contributes to the widening of the U.S. external debt and equity imbalances. The savings glut channel alone raises the U.S. external portfolio imbalance from −9% in 2002 to −76% in 2016, in the unit of 2002 U.S. GDP. We further differentiate the contributions from the developed markets and the emerging markets, and find that the imbalance is predominantly driven by the private savings from the developed markets.Second, official holdings also contribute to the widening of the U.S. external portfolio imbalances, leading to another 17% decline in the U.S. external portfolio imbalance from 2002 to 2016. One interesting finding is that the central bank purchases in the debt markets also spill over to the equity markets, as they raise debt valuation and encourage investors to substitute from debt to equity. As a result, both the U.S. and foreign investors also hold more equity across borders.Third, and most surprisingly, the investors’ demand shifts partially offset these trends, driving a reversal in the U.S. external portfolio imbalances from −94% to −32% in the unit of 2002 U.S. GDP. We do not directly observe this effect because it is overshadowed by the effects of savings glut and official holdings. So, when we combine all these channels, the U.S. external portfolio imbalances deteriorate considerably, but the deterioration would have been much greater if the investors’ demand had stayed constant. Further investigation shows that the investors’ demand is characterized by a market-wide shift from debt assets to equity assets, which impacts the U.S. external imbalances because the U.S. debt is widely held by foreigners.

“…Foreign holdings of U.S. assets have increased dramatically in the past two decades. At the end of 2019, non-U.S. investors held 16.8 trillion dollars’ worth of U.S. assets. By contrast, U.S. investors held only 10.2 trillion dollars in foreign assets1. This difference between the portfolio assets and liabilities resulted in a −$6.6 trillion net foreign asset (NFA) position for the U.S. in 2019, which amounts to 30% of U.S. GDP. This is a substantial deterioration from −$1.3 trillion in 2002, or 12% of U.S. GDP. The dashed line in Figure 1 shows this downward trend. These sustained net capital flows into the U.S. financial markets have been referred to as global imbalances(Lane and Milesi-Ferretti 2007a; Gourinchas and Rey 2014). As these imbalances are closely tied to the global risk-sharing arrangement and unique position of the U.S. in the international financial system, they have been a key focus of the international finance literature….”

Core finding, "... We begin by measuring the effects of the global savings glut in excess of domestic investment opportunities. These variables contribute to a 9.59% widening of the U.S. NFA per annum. In comparison, the actual U.S. NFA widens by 9.50% per annum in our sample from 2002 to 2019. In other words, our results imply that the global private savings alone are enough to account for the trend in U.S. portfolio imbalances. We further differentiate the contributions from different regions, and find that savings from the European developed markets are the predominant driver...."

Zhengyang Jiang, Robert Richmond and Tony Zhang, "A Portfolio Approach to Global Imbalances,"National Bureau Of Economic Research, July 2022, https://www.nber.org/papers/w30253

In this note, we examine how fiscal support impacted the balance between supply and demand across countries during the COVID-19 crisis. Our findings suggest that fiscal stimulus boosted the consumption of goods without any noticeable impact on production, increasing excess demand pressures in good markets. As a result, fiscal support contributed to price tensions. Indeed, focusing on inflation through February 2022 which does not capture many disruptions associated with the war in Ukraine, we show that countries with large fiscal stimulus, or with high exposure to foreign stimulus through international trade, experienced stronger inflation outbursts. Our back-of-the-envelope illustrative calculations suggest that U.S. fiscal stimulus during the pandemic contributed to an increase in inflation of about 2.5 percentage points (ppt) in the U.S and 0.5ppt in the United Kingdom. Unlike previous recessions, consumption of goods and services behaved very differently (see figure 2). In advanced economies, where the data allow real consumption expenditures across goods and services to be discernible more easily, consumption of services fell dramatically and then started recovering slowly as containment policies eased and vaccines were made widely available. In contrast, goods consumption fell by less during the beginning of the pandemic and experienced a strong recovery thereafter. Industrial production, however, was slow to adjust, creating a discrepancy between supply and demand in the goods' markets that likely played a role in the depletion of inventories and ultimately in recent price tensions Using our point estimates and country-specific values of fiscal support, figure 4 quantifies the role of fiscal support in shaping the response of goods consumption to fluctuations in mobility. The United States is the most impacted country, with consumption decreasing significantly less when mobility drops and rebounding significantly more when mobility increases. Keeping in mind the caveats described above, figure 5.1 presents the impact of domestic and foreign exposure on excess inflation for several regions, based on our regression estimates. The impact of domestic fiscal stimulus on inflation is highest in the United States. Canada, a country with strong trade links with the U.S., features a high level of excess inflation related to exposure to foreign fiscal stimulus. In large economies, not surprisingly, domestic stimulus is a more important driver of excess inflation than foreign stimulus. For example, domestic stimulus is associated with a 2.5 (ppt) in excess inflation in the United States, 1.8ppt in the Euro Area. Conversely, smaller economies are relatively more sensitive to foreign stimulus. In figure 5.2, we derive a measure of "international spillover" of U.S. fiscal stimulus. In particular, we isolate the share of U.S. stimulus in foreign exposure for several countries and compute the associated excess inflation in those countries. Our estimation implies that US fiscal stimulus was associated with an excess inflation of about 0.5 percentage points in the United Kingdom.

François de Soyres, Ana Maria Santacreu and Henry Young, "Fiscal policy and excess inflation during Covid-19: a cross-country view,"Federal Reserve Board, July 15, 2022, https://www.federalreserve.gov/econres/notes/feds-notes/fiscal-policy-and-excess-inflation-during-covid-19-a-cross-country-view-20220715.htm

Fiscal policy and excess inflation during Covid-19: a cross-country view

The recent surge in inflation in many countries around the world and the fiscal stimulus provided in the face of the COVID-19 pandemic has renewed interest in analyzing the potential role of large fiscal spending as a driver of price increases.

In this note, we examine how fiscal support impacted the balance between supply and demand across countries during the COVID-19 crisis. Our findings suggest that fiscal stimulus boosted the consumption of goods without any noticeable impact on production, increasing excess demand pressures in good markets. As a result, fiscal support contributed to price tensions. Indeed, focusing on inflation through February 2022 which does not capture many disruptions associated with the war in Ukraine, we show that countries with large fiscal stimulus, or with high exposure to foreign stimulus through international trade, experienced stronger inflation outbursts. Our back-of-the-envelope illustrative calculations suggest that U.S. fiscal stimulus during the pandemic contributed to an increase in inflation of about 2.5 percentage points (ppt) in the U.S and 0.5ppt in the United Kingdom.

1. The Covid Crisis and fiscal policy responses around the world

The COVID-19 pandemic greatly disrupted economic activity all over the world. Due to a mix of government-imposed restrictions and voluntary personal decisions, mobility levels, as measured by Google's geo-location tracking data from smartphones, collapsed in March 2020. Since then, mobility has improved, although with some volatility that tracked closely the successive waves of the pandemic (see figure 1).

While the pandemic and associated public health restrictions were the main drivers of economic fluctuations over the past two years, fiscal stimulus policies might have shaped the response of consumption and production to changes in mobility. Here, we investigate the association between the size of total fiscal stimulus and the path of consumption and Industrial Production during the COVID-19 pandemic, by evaluating: (i) the elasticity of demand and supply to lockdowns, and (ii) the impact of fiscal stimulus on this elasticity.

Empirical Setup.

Our empirical strategy consists of projecting quarterly real consumption and production growth on the growth rate in mobility in the same quarter. We also interact these variables with country-specific 2020 fiscal stimulus. Our objective is to analyze how fiscal support affected the country-level consumption and production in response to mobility fluctuations.4

On the one hand, in periods of mobility decline, we expect fiscal support to help household's "soften the blow" of the activity reduction, and hence expect a smaller decline in consumption in countries with large stimulus. Hence, in these periods, fiscal support is expected to counterbalance the effect of mobility, which means that the interaction term takes an opposite sign compared to the standalone mobility one. On the other hand, in periods of economic reopening and mobility rebound, we expect fiscal support to amplify the consumption increase, which implies that the interaction term takes the same sign as mobility.

Baseline Results.

We find that governments that provided generous fiscal support mitigated the drop in goods consumption in periods of lockdowns, while boosting consumption in periods of increased mobility. The effect of fiscal stimulus on services consumption, however, is insignificant. Finally, our results reveal that generous fiscal spending did not significantly contribute to supply expansion: countries with larger fiscal support did not have a significantly different association between mobility and Industrial Production. In other words, supply did not adjust quickly enough to meet the sharp increase in demand for goods.

Using our point estimates and country-specific values of fiscal support, figure 4 quantifies the role of fiscal support in shaping the response of goods consumption to fluctuations in mobility. The United States is the most impacted country, with consumption decreasing significantly less when mobility drops and rebounding significantly more when mobility increases.

The previous section highlighted that fiscal support boosted goods consumption demand without any noticeable impact on the supply of goods. Hence, the large increase in demand triggered by the fiscal stimulus policy, together with the slow pace of adjustment in production, likely contributed to the current imbalance in the goods market, resulting in the depletion of inventories, pronounced bottlenecks, and ultimately inflation.

The steep surge in goods consumption in countries with large fiscal support may have also created extra demand in other countries through an increase in demand for imports. This demand surge was met by limited supply capacity. Indeed, while both production, transportation and shipping capacity have adapted to increasing global value chain participation over the past few decades, the necessary infrastructure appeared to be quite inelastic in the short run. To further investigate this intuition, we turn to a cross-country regression analysis. For each country, we compute "excess inflation" by taking the 2021Q4 12-months inflation rate and subtract the average rate of inflation each country experienced during the 2015-2019 period. We then construct several measures of exposure to domestic and foreign fiscal stimulus and project excess inflation on such measures.

First, Exposure to Domestic Fiscal Stimulus captures each country's fiscal support, as presented in figure 3. Second, Exposure to Foreign Fiscal Stimulus measures a country's exposure to foreign stimulus and contains two parts: (i) a "vertical" component which is defined as a trade-weighted average of other countries' stimulus measures, and (ii) an "horizontal" component capturing the exposure of each country's import-partners to third countries' fiscal stimulus. Intuitively, the United States can be exposed to fiscal stimulus from Canada, both through a high import share (i.e, imported inflation) and through a high export share (i.e., higher demand from Canada). This captures vertical foreign exposure. Moreover, the price of Canada's exports to the United States may be pushed up by Canada's exposure to Mexico's fiscal stimulus. This captures horizontal foreign exposure.

We find that excess inflation is significantly correlated with each country's domestic stimulus, as well as with exposure to foreign stimulus. When taken separately or when used in conjunction with domestic fiscal stimulus, both vertical and horizontal exposure to foreign stimulus appear to be significantly correlated with domestic excess inflation. Moreover, our results show that excess inflation is also strongly related to our aggregated measure of Foreign Exposure.

Before describing our results further, we need to acknowledge several limitations in our analysis. Our estimation relies on the association between excess inflation and exposure to domestic and foreign fiscal stimulus, but it might be the case that countries that engaged in larger fiscal support are also those that have been the worst hit by the pandemic and thus had a greater recovery. In such a case, and if the severity of the pandemic is itself positively correlated with excess inflation in the recovery period over and beyond the effect of fiscal support, then we would suffer from an omitted variable issue bias. Moreover, the bias would be positive because our fiscal stimulus variable would capture both the direct effect of the pandemic and the effect of the fiscal spending. Future work on this topic would gain from addressing such concern. For the moment, the results should be viewed as illustrative, highlighting perhaps the higher end of potential price pressures from fiscal stimulus during the pandemic.

Back-of-the-Envelope Calculation: Quantifying the Impact of Fiscal Stimulus on Inflation.

Keeping in mind the caveats described above, figure 5.1 presents the impact of domestic and foreign exposure on excess inflation for several regions, based on our regression estimates. The impact of domestic fiscal stimulus on inflation is highest in the United States. Canada, a country with strong trade links with the U.S., features a high level of excess inflation related to exposure to foreign fiscal stimulus. In large economies, not surprisingly, domestic stimulus is a more important driver of excess inflation than foreign stimulus. For example, domestic stimulus is associated with a 2.5 (ppt) in excess inflation in the United States, 1.8ppt in the Euro Area.

4. Conclusion.

The COVID-19 pandemic hampered firms' ability to produce and consumers' ability to consume. In response to economic disturbances, many governments resorted to large fiscal stimulus. This policy was successful at boosting consumption which, together with relatively inelastic supply, may have led to supply chain bottlenecks and price tensions.

However, one should also recognize the positive role played by generous government support throughout this unprecedented crisis. The large spending supported a strong economic rebound, with both GDP and employment recovering at a remarkable pace, likely preventing worse outcomes despite the price pressures that may have resulted from the spending.

References.

Amiti, Mary; Heise, Sebastian and Wang, Aidan. "High Import Prices along the Global Supply Chain Feed Through to U.S. Domestic Prices." Federal Reserve Bank of New York Liberty Street Economics, November 8, 2021.

Leibovici, Fernando and Dunn, Jason. "Supply Chain Bottlenecks and Inflation: The Role of Semiconductors." Federal Reserve Bank of St. Louis Economic Synopses, 2021, No. 28.

Ana Maria Santacreu and Jesse LaBelle, "Supply Chain Disruptions During the COVID-19 Recession," Economic Synopses, No. 2, 2022.

Santacreu, Ana Maria; Leibovici, Fernando and Jesse, LaBelle. "Global Value Chains and U.S. Economic Activity During COVID-19." Federal Reserve Bank of St. Louis Review, Third Quarter 2021, 103(3),pp. 271-88.

Santacreu, Ana Maria and LaBelle, Jesse. "Rethinking Global Value Chains During COVID-19: Part 1." Federal Reserve Bank of St. Louis Economic Synopses, 2021a, No. 16.

Santacreu, Ana Maria and Jesse LaBelle. "Rethinking Global Value Chains During COVID-19: Part 2." Federal Reserve Bank of St. Louis Economic Synopses, 2021b, No. 17.

Santacreu, Ana Maria and Jesse LaBelle, "Global Supply Chain Disruptions and Inflation During the COVID-19 Pandemic," Federal Reserve Bank of St. Louis Review, Forthcoming 2022.

Sargent, Thomas J. and Wallace, Neil. "Some Unpleasant Monetarist Arithmetic." Federal Reserve Bank of Minneapolis Quarterly Review, Fall 1981,pp. 1-15.

Sims, Christopher A. "Stepping on a Rake: The Role of Fiscal Policy in the Inflation of the 1970s, https://doi.org/10.1016/j.euroecorev.2010.11.010." European Economic Review, 2011, 55(1): 48-56.

Kehoe, Timothy and Nicolini, Juan Pablo (editors). "Monetary and Fiscal History of Latin America, 1960-2017", 2021, University of Minnesota Press

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1. François de Soyres (Francois.m.deSoyres@frb.gov) and Henry Young (Henry.l.Young@frb.gov) are with the Board of Governors of the Federal Reserve System. Ana Maria Santacreu (Ana.M.Santacreu@stls.frb.org) is with the Federal Reserve Bank of St Louis. The views expressed in this note are our own, and do not represent the views of the Federal Reserve Bank of Saint Louis, the Board of Governors of the Federal Reserve, nor any other person associated with the Federal Reserve System. Return to text

2. See Santacreu and LaBelle (2022) Return to text

3. Several aspects of this line of reasoning, including the role of semiconductors and the importance of supply-chain bottlenecks, have been documented in recent contributions such as Amiti et al. (2021), Leibovici and Dunn (2021), Santacreu et al. (2021), Santacreu and LaBelle (2021a, 2021b, 2022) Return to text

4. In our baseline specifications, we use country fixed effects to account for unobservable factors such as heterogeneous trend growth across countries. Our results are qualitatively similar with different fixed effects. Return to text