William Dudley, former President and CEO of the Federal Reserve Bank of New York, was a keynote speaker at this year’s Nomura Investment Forum Asia.
State of the economy
The US economy is growing rapidly as the reopening process is underway and vaccinations increase. That said, we are still a long way from where we were in the US labor market. We are still about 8 million jobs short of where we were in Feb 2020 before the pandemic started. It is early days of better news, but still a long way to go. We are seeing a lot of price pressures relatively early compared to what we might have anticipated in a normal business expansion. One of the things that makes this recovery very different from the one that followed the great financial crisis is that households, going into the recovery, are in a flush condition. We've never really had a recovery like this. It will be interesting to see how long demand from consumers can be sustained as the fiscal stimulus starts to wane as we get into the second half of 2021.
Fiscal policy
The household sector has a high savings rate and a strong balance sheet in the aggregate right now, which means things will be sustained better than people think. Also, monetary policy is providing as much stimulus as it possibly can. The US is recovering sooner, so the rest of the world will hold the US back a little, there will probably be some drag on trade and the trade deficit will widen in the near term. But then as you get into 2022, and the vaccination regime is broadened out to many other countries, then you'll see strong recovery elsewhere in the world.
I'm in the camp that the recovery will be better sustained than people think, even with fiscal policy stimulus lessening. The big wildcard is what the Biden administration will actually be able to get done in Washington with only 50 senators. It will be tricky for the administration to even get their infrastructure spending bill through Congress. We shouldn’t count our fiscal stimulus chickens quite yet because of the narrow margin the Democrats have in the US Senate.
Inflation
The question the Fed keeps getting asked is if inflation is transitory or not, and the response is that it is transitory. The economy is re-opening very quickly, and the workers, goods and services aren't in the right place and it takes time to sort that all out.
It's transitory because sustained higher inflation requires a couple of other things to happen – like true pressure on resources in a sustained way and that means the US labor market. We have about 8 million people unemployed and it would be unusual to have a big inflation problem with that much slack in the labor market.
Secondly, if you look at the actual trends of wage inflation, it's still modest. On a year on year basis, private workers’ wages are up 2.8 percent. It's hard to have an inflation problem with wage gains of that low magnitude.
And the third part of the puzzle is what's happening to inflation expectations. We've seen about 30-40 basis points increase in the measure of inflation calculated by the difference of nominal treasuries relative to inflation protected securities. Even though it's moved up sharply in the last few months, the level isn't really different from the average of the last decade.
If inflation expectations keep going up, that will definitely be problematic, but if they were to stabilize right here, I don't view it as a serious problem.
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