Persistent Profits Recession?

The Q3 earnings season starts early next month. There is already some chatter about the profits recession persisting for the sixth quarter in a row. I am in the camp that believes that it ended during Q2 and comparisons should turn positive during the second half of this year into next year. Let’s see what I may or may not be missing:

(1) Profits recession: A bottom? The 9/25 WSJ featured an article on this subject titled “Profit Slump for S&P 500 Heads for a Sixth Straight Quarter.” According to the story: “The third quarter was supposed to be when earnings growth returned to U.S. companies. Not anymore. Companies in the S&P 500 are now expected to report an earnings decline for the sixth consecutive quarter in the coming weeks, according to analysts polled by FactSet. That slump would be the longest since FactSet began tracking the data in 2008.”

I use S&P 500 actual operating earnings and analysts’ consensus operating earnings expectations data compiled by Thomson Reuters. On a year-over-year basis, earnings have been falling for the past four quarters through Q2-2016. Earnings are down 2.9% since they peaked in Q4-2014. However, the most recent low in this series occurred during Q1 of this year when earnings were down 11.7%, suggesting that might have been the bottom of the recession, though the y/y comparisons remained negative through Q2.

(2) Revenues: An upturn? My optimistic spin on earnings is supported by S&P 500 revenues, which declined on a y/y basis from Q1-2015 through Q4-2015. However, the actual level of revenues admittedly has been volatile in a flat range (though near recent record-high territory) since mid-2014, when the price of oil started to plunge.

(3) Analysts’ consensus: Another hook? The Thomson Reuters data confirms the WSJ story, which is based on FactSet data. The Q3 consensus estimate turned negative on a y/y basis recently, and was -0.8% last week. However, as I have noted going into every earnings season since the start of the bull market, actual results often tend to exceed downwardly revised estimates just before the earnings season begins. Let’s call it the “earnings hockey stick.” The average hook in the stick since Q2-2009 through Q2-2016 has been 4.8%. There wasn’t one quarter over this period with a negative surprise.

The positive surprise for Q2-2016 was 3.6%. It won’t take that much of a positive surprise to produce a positive y/y comparison for Q3-2016.

(4) Forward earnings: What really matters. I believe that the stock market discounts forward earnings, i.e., the S&P 500 12-month forward consensus expected operating earnings. It is a time-weighted average of analysts’ earnings estimates for this year and next year, and is usually a good year-ahead leading indicator of actual earnings. When the earnings season starts in October, forward earnings will give a weight of only 3/12 to this year’s estimate and 9/12 to next year’s estimate.

Doing this calculation using weekly data shows that the S&P 500 forward earnings has rebounded nicely since the spring of this year and is back at $129.20 per share, near the record highs of 2014. That’s because it is converging to the current estimate of $133.57 for 2017. I just added 2018 consensus estimates to our numerous earnings charts. Analysts are currently predicting $147.49 per share for 2018. While those numbers are bound to be revised downward over time, as typically occurs, there’s certainly no profits recession in the analysts’ earnings outlook for the next couple of years.

Inflation: Healthy & Unhealthy

Bob Wiley, the anxiety-prone obsessive-compulsive character played by Bill Murray in “What About Bob?,” tells his psychiatrist, played by Richard Dreyfuss, “There are two types of people in this world: those who like Neil Diamond, and those who don’t.”

Previously, I’ve often argued that there are two kinds of deflation. In a period of good deflation, consumer prices fall as a result of competition, technological innovation, and productivity. Consumers’ purchasing power increases and they spend more, which results in more demand and more jobs. The standard of living improves.

Bad deflation typically occurs after a prolonged period of easy credit. The stimulative impact of easy credit is increasingly dampened by the burden of accumulated debt, which weighs on demand. Meanwhile, supply is plagued by too much capacity as easy money allows the living-dead “zombie” producers to stay in business. Zombies are very sociable. They create more zombies as profitable companies become unprofitable competing with them. Debt servicing becomes more onerous as the profits recession is exacerbated by falling prices. A dangerous deflationary spiral is often triggered by the bursting of speculative bubbles that had been inflated by easy money.

There are also two kinds of inflation. There’s the kind that stimulates demand by prompting consumers to buy goods and services before their prices move still higher. The other kind of inflation reduces the purchasing power of consumers when prices rise faster than wages. That variety of inflation certainly doesn’t augur well for consumer spending.

During the 1960s and 1970s, price inflation rose faster than interest rates. The Fed was behind the inflationary curve. So were the Bond Vigilantes. However, wages kept pace with prices because unions were more powerful than they are today, and labor contracts included cost-of-living adjustments. Back then, the University of Michigan Consumer Sentiment Survey tracked rising “buy-in-advance” attitudes. Those attitudes remained particularly strong in the housing market through the middle of the previous decade. On balance, inflation stimulated demand more than weighed on it. Borrowing was also stimulated.

Today, the major central banks would like to revive buy-in-advance attitudes, along with inflationary expectations, to boost demand for goods and services. For various reasons, the central bankers have failed to increase their inflation measures back up to their 2.0% targets. Despite several years of ultra-easy monetary policy since the financial crisis of 2008, the ECB’s preferred measure (i.e., the headline CPI) has been under 2.0% since February 2013, and was up only 0.2% y/y through August. The BOJ’s preferred inflation measure (i.e., “core” inflation excluding only food) has been under 2.0% since April 2015, and was 0.5% through July.

In the US, there is some confusion about whether Fed officials are targeting the headline or the core PCED inflation rate. In the past, they all seemed to focus on the core rate excluding food and energy. More recently, even individual FOMC participants have mentioned both as worth monitoring. In any event, both remain below the Fed’s 2.0% target, with the headline at 0.8% and the core at 1.6%.

A few Fed officials believe that the core is close enough to 2.0% to hike the federal funds rate again soon. Others say that having stayed stubbornly below 2.0% for most of the time since October 2008, what’s the rush to raise rates? This afternoon, we will all find out whether the doves or the hawks won the debate at the latest meeting of the FOMC.

Both sides are missing an important development on the inflation front. The variety of inflation that the US is experiencing isn’t the kind that stimulates economic growth. On the contrary, it has been led by rising rents, and more recently by rising health care costs. It is very unlikely that buy-in-advance attitudes cause people to rent today because rents will be higher tomorrow, or to rush to the hospital to get a triple-bypass today because it will be more expensive tomorrow! Higher shelter and health care costs are akin to tax increases because they reduce the purchasing power available for other goods and services. Consider the following:

(1) The rent is too d@mn high! Tenant rent accounts for 5% of the core PCED and 10% of the core CPI. In August, it was up 3.8% y/y in the CPI, well ahead of the increase in the core rate. That can’t be good for consumers’ purchasing power given that a record 37% of all households were renters during Q2-2016. The tenant-rent data are used to construct owners’ equivalent rent (a very strange concept, indeed!), which accounts for 13% of the core PCED and 31% of the core CPI. It was up 3.3% y/y during August, the highest pace since June 2007. Why would anyone at the Fed think that’s a happy development, since it doesn’t really have any effect one way or the other on anyone, because what homeowners rent their homes from themselves!?

(2) Obamacare’s stealth mission almost accomplished. Of course, 100% of households rely on our health care system. August’s CPI had some really bad news on this front. There were big increases in health care prices as the overall health care index jumped 1.0% m/m (the most since February 1984) and 4.9% y/y (the highest since January 2008).

It’s not clear why the surge occurred during August, but it may be related to the expansion of healthcare coverage under Obamacare. There has certainly been an increase among the population with pre-existing conditions, which has significantly boosted costs for all. Many conservatives always suspected that Obamacare was designed to fail so that the government would have to save the day with a nationalized single-payer system.

By the way, one of the main reasons that the CPI inflation rate exceeds the PCED rate is because the latter doesn’t include health care spending paid for by the government through Medicaid and Medicare. Nevertheless, when August’s PCED is released on September 30, it may very well hit the Fed’s 2.0% target thanks to rapidly rising rents and health care costs. For the man and woman on the street, congratulations to the Fed will not be in order. However, I won’t be surprised if Fed officials jubilantly declare: “Mission accomplished!”

Slip Sliding in the Oil Patch

China’s latest economic indicators showed some strength. However, that strength hasn’t shown up in commodity prices. China’s industrial production and real retail sales rose 6.3% and 9.3% y/y through August. While those growth rates were a bit better than expected, they remain close to recent cyclical lows in both series.

The CRB raw industrials spot price index rebounded earlier this year from last year’s plunge. It has been meandering sideways since the spring. The index includes the price of copper, which is highly correlated with the growth rate in China’s industrial production. Both remain in their downward trends of the past few years.

Like the CRB index, the price of a barrel of Brent crude oil recovered earlier this year after plunging by 76% from mid-2014 through early 2016. It has been hovering between $42 and $52 since mid-April.

In many ways, the price of oil is the tail that’s wagging the dog. It is highly inversely correlated with the trade-weighted dollar. Causality probably runs both ways, so a weaker (stronger) oil price seems to put upward (downward) pressure on the dollar. That may be because oil exporters have fewer (more) dollars to convert to other currencies when the price is weak (strong).

Of course, there is a feedback effect from the dollar to oil and other commodity prices. The CRB raw industrials spot price index, which doesn’t include oil, tends to strengthen (weaken) when the dollar is weak (strong).

For now, I foresee the choppy sideways actions of the dollar, oil prices, and other industrial commodity prices continuing through the middle of next year. The Fed’s process of gradually normalizing interest rates is turning out to be very gradual, which should keep the dollar from moving higher given that it is up 19% from its low on July 1, 2014. On Monday, Fed Governor Lael Brainard said that the Fed/US econometric model shows that such an increase is equivalent to a 200bps hike in the federal funds rate. In other words, the foreign exchange market has already done much of the Fed’s work.

Nevertheless, if the oil market’s fundamentals push the price of oil back down again, the dollar could move still higher and depress other commodity prices. So let’s review the latest developments in oil’s supply and demand:

(1) Inventories. The combination of weak demand and increased OPEC output pushed oil inventories in developed nations to a record 3.1 billion barrels in July. Yesterday, the International Energy Agency (IEA) predicted that the surplus in global oil markets will last for longer than previously estimated. So world oil stockpiles will continue to rise through 2017, resulting in a fourth consecutive year of oversupply. Just last month, the IEA predicted the market would return to equilibrium this year.

(2) Supply. The IEA’s revised estimates of the supply/demand oil balance on Tuesday followed a similar revision by OPEC on Monday. The 9/12 WSJ reported: “In its closely watched monthly report on market conditions, OPEC said non-OPEC members like the U.S., Russia and Norway will produce about 190,000 barrels a day more than expected in 2016, a sign that production outside the cartel has remained resilient despite low prices. By 2017, the cartel’s data suggests that oil supplies will outstrip demand by an average of about 760,000 barrels a day, over three times higher than OPEC predictions made just last month.”

(3) Strategic petroleum reserve. In August, the US Department of Energy released its “Long-Term Strategic Review of the U.S. Strategic Petroleum Reserve.” It said that instead of the nearly 700 million barrels the US currently stockpiles, an SPR around 530-600 million barrels would be more appropriate. Much has changed since the SPR was set up in the aftermath of the 1973 oil embargo. The US is one of the largest oil producers in the world, so energy security isn’t as important.

(4) US production. That all seems very bearish for oil prices. However, keep in mind that lower oil prices probably will continue to reduce oil production in the US. Arguably, the new swing producer in the oil market is now the US rather than Saudi Arabia. The weekly US oil rig count seems to be a very good 18-month leading indicator of weekly oil field production in the US.

Production is down 11.5% from a recent high of 9.6mbd during the week of July 3, 2015 to 8.5mbd during the week of September 2, 2016. The rig count has rebounded slightly in recent weeks, but remains down sharply from the peak of late 2015. The implied drop in US oil production could provide some bullish support to offset the bearish factors highlighted in the IEA and OPEC reports.

Meanwhile, US gasoline demand over the past 52 weeks through the 9/2 week rose to 9.3mbd, matching the previous record high during 2007.

On the other hand, Apache found lots more oil last week. The 9/7 WSJ reported: “Apache Corp. said it has discovered the equivalent of at least two billion barrels of oil in a new West Texas field that has the promise to become one of the biggest energy finds of the past decade. The discovery, which Apache is calling ‘Alpine High,’ is in an area near the Davis Mountains that had been overlooked by geologists and engineers, who believed it would be a poor fit for hydraulic fracturing.”

US Economy’s Big Soft Spot

Why has nonfarm business productivity growth been so weak during the current economic expansion? That’s been an ongoing puzzle. I have noted that most of the jobs gains since payroll employment troughed during February 2010 have been in service-producing industries, where productivity tends to be weaker than in goods-producing industries that can deploy automation and robotics more effectively.

Since that employment bottom back in February 2010 through August of this year, payrolls are up 14.9 million, led by a 13.2 million increase in private services employment. However, that’s not a new development. The ratio of goods-producing payroll employment to total payroll employment has been declining since August 1943. It is down from 44.1% back then to 13.6% now. In other words, the percentage of total employment in services is up from 55.9% to 86.4% over the same period.

The big surprise in the economy’s productivity slowdown is the remarkable weakness in manufacturing productivity during the current expansion. That has weighed heavily on the slowdown in overall nonfarm productivity.

The ratio of nominal goods output in real GDP has also been on a downward trend since Q1-1948. It has declined since then from 52.3% to 29.6% currently. However, manufacturing industrial production managed to rise to a record high during December 2007, and it has regained 18.8% since its recent recession bottom during June 2009, though it has remained stalled since mid-2014 at 5.8% below its previous record high.

The quarterly productivity release tells the same story for the real output of manufacturing, which also has stalled since mid-2014, though back at its previous record high during Q1-2008. The sad part of the story is that the y/y growth rates in both measures of factory output have slowed significantly during the current expansion down to zero, contributing to the slow pace of overall economic growth, including the significant slowdown in overall productivity.

The problem may be that many factories have reached “peak productivity.” They are fully automated. They are extremely productive from a supply-side perspective. In a world of secular economic stagnation and plenty of excess capacity, the demand side of the productivity equation is weak. As I have noted before, the productivity of the most efficient widgets plant in the world is zero if there is no demand for widgets.

There’s lots of demand for US manufactured goods given that the sector’s real output is back at the previous cyclical high. It just isn’t growing. Auto sales seem stalled at a cyclical high of around 17.0 million units (saar). Housing starts have recovered but have yet to rise meaningfully above previous cyclical lows. Real merchandise exports have been relatively flat for the past two years in record-high territory. Non-defense capital goods orders excluding aircraft is down 6.5% over the past 24 months through July. The weakness in exports and capital goods has coincided with the weakness in demand for energy-related goods and services since mid-2014.

Let’s have a closer look at some of the other recent unhappy numbers for manufacturing:

(1) Productivity. Hours worked in manufacturing has declined by 27% from the start of the data in Q1-1987 through Q2-2016. Over the same period, the sector’s output is up 85% as a result of big productivity gains. During the current expansion, manufacturing productivity growth has been practically zero since Q3-2012.

The 20-quarter (five-year) growth rate in manufacturing productivity plunged from a high of 8.5%, at an annual rate, during Q1-2008 to 0.9% during Q2-2016. The data for this growth rate start in 1992. I’ve constructed a proxy for manufacturing productivity (using monthly production and employment data for manufacturing), which currently shows a comparable growth rate of just 0.4%, the lowest on record starting in 1952!

(2) Purchasing managers. I thought that the slowdown in manufacturing was mostly attributable to the plunge in energy businesses’ activity resulting from the plunge in oil prices. Now that they have recovered somewhat from their lows at the beginning of the year, I expected to see better manufacturing numbers by now. That’s not happening, so far.

Indeed, August’s M-PMI was certainly disappointing across the board. The overall index as well as its three major components (orders, production, and employment) all were just under 50.0 last month.

Some of the weakness in manufacturing may be starting to rub off on services. The NM-PMI dropped 4.1 points from 55.5 during July to 51.4 in August. Here too, all three major components dropped last month, though they all remained above 50.0.

(3) Regional surveys. The averages of the composite, orders, and employment indexes of the business surveys conducted by five Fed districts (Dallas, KC, NY, Philly, and Richmond) all were slightly negative last month. So they are confirming the weakness in the latest national M-PMI survey.

(4) Bottom line. The Atlanta Fed’s GDPNow model forecast for real GDP growth in Q3-2016 was 3.5% on September 2. As I noted recently, the labor market and consumer spending indicators support that solid forecast. However, the manufacturing data and the services PMI do not. If Fed officials are intent on getting one rate hike done this year, following last year’s one-and-done, they might consider doing it at the upcoming FOMC meeting on September 20-21. The next batch of economic indicators might not give them another chance to justify a rate hike this year. We are in a fine mess if the Fed can’t justify one measly 25-bps rate hike per year.

FRB Governor Stanley Fischer may be about to lose all his credibility. He predicted four rate hikes at the beginning of the year for 2016. Last week, he was down to two rate hikes for the year.

Abnormal Normalization

When in doubt, simulate. That was my second takeaway from Fed Chair Janet Yellen’s highly anticipated Jackson Hole speech on Friday. The first takeaway was the one that made all the headlines. She is joining the chorus of Fed officials who have been saying it is time for another rate hike: “Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.” That seems to be the Fed’s new party line, as recently also expressed by Fed Vice Chair Stanley Fischer and FRB regional presidents William Dudley (NY), John Williams (SF), Dennis Lockhart (ATL), and Loretta Mester (CLE).

To make sure that we are left with no reason to be certain about what the Fed will do, she added, “And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course.”

Then she really let us have it by offering a chart of the Fed’s known unknown. It shows a line tracing the median path for the federal funds rate through the end of 2018 based on the FOMC’s summary of economic projections in June. Its Figure 1 also shows a shaded region on either side of the line, which is based on the historical accuracy of private and government forecasters. The amazing result is that there is a 70% probability that the federal funds rate will be between zero and 3-1/4% at the end of next year and between zero and 4-1/2% at the end of 2018! Yellen may be test-marketing this “fan chart” to replace the quarterly “dot plot” of the federal funds rate reflecting the forecasts of the FOMC participants.

I wish I could get away with such wide-ranging forecasts. My latest view is that it will be one-and-done for federal funds rate increases this year and one-and-done next year. That would bring the federal funds rate up to 1.0% by the end of next year. And that might be all for a long time. In other words, I expect that the process of normalizing monetary policy will be abnormally gradual and limited in scope and duration. I call it “abnormal normalization.”

Yellen provided the following explanation for her drive-a-convoy-of-trucks-through range for the federal funds rate outlook: “The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted. When shocks occur and the economic outlook changes, monetary policy needs to adjust. What we do know, however, is that we want a policy toolkit that will allow us to respond to a wide range of possible conditions.” Fed officials call that “forward guidance.” In other words, we are on our own.

The rest of her presentation was a relatively technical discussion of the subject of her speech titled “The Federal Reserve’s Monetary Policy Toolkit: Past, Present, and Future.” In other words, it was addressed to the high-powered monetary intelligentsia in the room rather than all the rest of us among the rabble. She reviewed the rather limited pre-crisis toolkit, then the tools that have been added since the crisis. Allow us to cut through the jargon:

(1) Post-crisis toolkit. Yellen noted that in 2006, Congress approved plans to allow the Fed to pay interest on banks’ reserve balances beginning in 2011. In the fall of 2008, Congress moved up the effective date of this authority to October 2008. She stated, “That authority was essential. Paying interest on reserve balances enables the Fed to break the strong link between the quantity of reserves and the level of the federal funds rate and, in turn, allows the Federal Reserve to control short-term interest rates when reserves are plentiful.” They certainly were plentiful, as the Fed implemented a series of QE programs starting in November 2008. Yellen also touted “forward guidance” as another new post-crisis tool in the toolkit.

(2) Too close to zero. Until very recently, the Fed was focused on “normalizing” monetary policy very gradually so as not to undermine what seems like self-sustaining economic growth. Now, the Fed is starting to worry about the next recession and whether there will be enough room between the federal funds rate and zero to stimulate the economy. Yellen observed that most forecasts currently show the federal funds rate rising no higher than 3% in the longer run. Between 1965 and 2000, it averaged more than 7%. “Thus, we expect to have less scope for interest rate cuts than we have had historically,” Yellen stated.

(3) Why so low? The reason that the federal funds rate isn’t expected to rise any higher than 3% is because inflation is expected to stabilize around 2%, while the “neutral” real federal funds rate is expected to be only 1%. Get it? 1+2=3. During past economic expansions, the real rate seemed to be more like 2%-3%.

The real rate is supposed to be the federal funds rate minus expected inflation, which is hard to measure. There are survey data for expected inflation. There is also the yield spread between the 10-year nominal bond yield and the comparable TIPS. In my opinion, it doesn’t make much sense to use expected inflation over the next several years to inflation-adjust an interest rate that is for funds borrowed and deposited overnight by bankers. So I use the actual core CPI inflation rate instead.

The “neutral” real rate, that neither boosts nor slows the economy, dropped in recent years, according to Fed officials. Why is that so and why might it remain depressed? Yellen offers the following smorgasbord: “Several developments could have contributed to this apparent decline, including slower growth in the working-age populations of many countries, smaller productivity gains in the advanced economies, a decreased propensity to spend in the wake of the financial crises around the world since the late 1990s, and perhaps a paucity of attractive capital projects worldwide. Although these factors may help explain why bond yields have fallen to such low levels here and abroad, our understanding of the forces driving long-run trends in interest rates is nevertheless limited, and thus all predictions in this area are highly uncertain.”

Or as Stanley Fischer recently admitted in his 8/21 speech on the slowdown in productivity: “We just don’t know.” Indeed, no one even knows if the neutral real rate concept makes any sense whatsoever. It can be lumped together with the Loch Ness monster, leprechauns, unicorns, and UFOs. None of them have ever been convincingly sighted by sober observers.

Some sober critics of the Fed and other central banks have observed that by keeping interest rates near zero, monetary policy may be an important source of secular stagnation, which is why the real rate is so low. Savers are earning less and are forced to save more. Corporations are using cheap money to buy back their shares rather than invest. Zombie companies that should be out of business are able to stay in business by refinancing at low rates and keeping their excess capacity on line, depressing prices and profits. And on the fiscal side, a significant portion of the government’s budget deficit is financing entitlement programs rather than infrastructure spending. The monetary authorities are enabling the fiscal authorities to do this at very low interest rates. Burdensome taxes and regulations may also be contributing to secular stagnation in the US and around the world.

(4) Fun with econometric models. When reality bites the forecasts of macroeconomists, they don’t curl up in a ball and mutter quietly to themselves in the corner. Instead, they simulate reality with their econometric models and show why they are right after all, at least in their simulated world. In her speech, Yellen acknowledged that a 3% federal funds rate (assuming that it ever gets there again in our lifetime) may not leave enough room to ease during the next average-style recession, based on previous experience.

Not to worry: A recent Fed working paper is reassuring, at least to Yellen. It is by David Reifschneider and titled “Gauging the Ability of the FOMC to Respond to Future Recessions.” Its conclusion is very reminiscent of arguments made by both William Dudley and former Federal Reserve Chair Ben Bernanke for QE2 during November 2010. They both said that the Fed’s econometric model showed that the federal funds rate needed to be lower than zero. But the Fed’s mantra back then and still now is that zero is the “zero bound.” Negative interest rates remain off the table (for now).

Back in 2010, the Fed’s model showed that a negative 0.75% federal funds rate was needed and that it could be accomplished, in effect, with QE2 purchases of $600 billion in Treasury bonds. At the time, I wrote that there was either something wrong with the model or the Fed was trying to fix a problem that couldn’t be fixed with monetary policy. (See our Chronology of Fed’s QE.)

Reifschneider’s latest iteration of this exercise comes up with the same conclusion: If the Fed’s econometric model shows that the federal funds rate should be lowered below zero during the next recession, that can be achieved effectively with another QE move and more forward guidance. Yellen admits that these tools might be pushed to their limits if the federal funds rate gets up only to 2% rather than 3%. In any event, the federal funds rate currently is only 0.25%-0.50%, and may or may not be up to 0.50%-0.75% by the end of this year. As the song goes: “It’s a long way to Tipperary.”

(5) Other options. No wonder that Yellen is reaching out to her staff and other economists for more tools to run monetary policy. Interestingly, in her speech, she didn’t mention negative interest rates. She did mention that QE purchases could be broadened to other assets. Might that include corporate bonds and equities? She didn’t say.

Yellen did mention raising the 2% inflation target, as some economists have advocated. Sorry, I think that’s nutty. The Fed can’t even get it up to 2%; why would Fed officials want to embarrass themselves by raising the bar? She mentioned that fiscal policy could play a role, but stayed clear of suggesting helicopter money.

(6) Unreal rate. Lots of accounts have been asking me to help them understand the neutral rate concept and why Fed officials are suddenly so obsessed with it. Stanley Fischer explained it better than I could in his 8/21 speech:

“And there have been other issues of concern to those particularly interested in monetary and macroeconomic policy, though probably of less explicit concern to the public: The decline in estimates of r*--the neutral interest rate that neither boosts nor slows the economy--which is related to the fear that we are facing a prolonged period of secular stagnation; the associated concerns that (a) the short-term interest rate will be constrained by its effective lower bound a greater percentage of time in the future than in the past, and (b) that the U.S. economy could find itself having to contend at some point with negative interest rates--something that the Fed has no plans to introduce; the fear that very low interest rates present a threat to financial stability; and concerns that low rates of real wage growth are increasing inequality in the distribution of income.”

Is that clear? Well, in any event, I reviewed the relationships between the real federal funds rate (using the current core CPI inflation rate) and the variables mentioned by Yellen as possibly explaining why the real rate is low. I didn’t find much when I compared the real rate to the growth rate of the US working-age population, US productivity growth, the US personal saving rate, and the capacity utilization rate.