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This edition was written by Sarah Ahmad, Tristan Loa, Georgia Nabors, and David Wessel.
Ricardo J. Caballero of MIT, Tomás E. Caravello of MIT, and Alp Simsek of Yale argue that central banks should target a Financial Condition Index (FCI), a summary measure of asset prices such as stocks, bonds, real estate, and exchange rates, because asset prices play a large role in driving aggregate demand. The authors reason that stabilizing the FCI would reduce noisy financial flows—shifts in asset demand or supply unrelated to fundamentals—that can account for up to 55% of financial condition variance and up to 50% of output gap variance. By announcing and maintaining a predictable FCI target, the authors argue, arbitrageurs will trade more aggressively, reducing the noise shocks before they can hurt the economy. The authors estimate that using FCI targeting between 2000 and 2007 would have reduced the variance of the output gap by 36%, of inflation by 2%, and of interest rates by 6%. Compared to forward guidance, FCI targeting achieves a similar inflation variance but a 21% lower output gap variance, making it a potentially effective instrument to stabilize the economy.
Jaison R. Abel and Richard Deitz of the Federal Reserve Bank of New York develop a new measure of long-term labor market disengagement called the detachment rate—the share of the population that has been out of the workforce for more than a year. They find that the detachment rate for prime-age men (ages 25-54) rose from 4% in 1980 to 9% in 2015. For prime-age women, the detachment rate declined between 1980 and 2000 as labor force participation increased. From 2000 to 2015, however, women’s detachment rate increased from 16% to 22%. Detachment fell for both men and women between 2015 and 2019 due to improving labor market conditions after the Great Recession. The authors attribute the decline in attachment since 2000 to increased import competition and automation, which reduced routine jobs, especially in manufacturing and administration. The increase in labor market detachment for both men and women was more pronounced in geographic areas with a greater decline in these occupations. Areas with more high-skill workers experienced a smaller increase in detachment. They also find that the increase in detachment was largest among older prime-age adults and individuals without a college degree.
Advances in clean energy technologies and the adoption of stringent climate policies are likely to reduce global demand for crude oil. Will oil producers respond to this anticipated decline in demand by reducing near-term investment in wells and other infrastructure and subsequently increase oil extraction (the disinvestment effect)? Or will they accelerate oil extraction (the green paradox)—potentially increasing climate damage? Ryan Kellogg of University of Chicago finds that the disinvestment effect dominates, especially for non-OPEC producers. He estimates that an anticipated 75-year decline in oil demand to zero would reduce cumulative oil extraction by 27.1% compared to a scenario where demand growth is expected to be steady.
"Q: The expectation is that you're going to cut rates. but I'm curious about why? Why is that the expectation? We're still in a moment where it appears that inflation looks a little bit stickier than we thought it did and the economy is stronger in many ways than we have expected. So, the question is what is the cost of waiting?"
"A: Let me take a step back on that and just say that the… U.S. economy is doing very well," says Jerome Powell, Chair of the Federal Reserve Board (video). "We are in a very good place with the economy. We are growing at around 2.5% and inflation has come down. Headline inflation was as high as 7.2% and now it is at 2.3%. Unemployment is at 4.1% and it is higher than a few years ago but it is at a very low level. We are not quite there on inflation but we are making progress. The backstory is that the U.S. economy is in a very good shape and there is no reason for that to not continue. So, we raised rates to 5.25% to 5.50% and we held that for 14 months. Other central banks had already started cutting, we were the last major central bank to cut. We are on a path to bring rates down to a neutral level over time. But you are right, the economy is strong and stronger than we thought it would be in September. So, the labor market is better and downside risks appear to be less in the labor market. Growth is definitely stronger than we thought and inflation is coming a little higher. The good news is that we can afford to be a little more cautious as we try to find neutral."
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