Minding Ag's Business

KC Fed President: Policymakers Should Stay Flexible as Economy Works Toward New Equilibrium

Katie Micik Dehlinger
By  Katie Micik Dehlinger , Farm Business Editor
Esther George, president of the Federal Reserve Bank of Kansas City and member of the Federal Open Markets Committee, said monetary policy will remain accommodative as the economy works through the aftereffects of the pandemic. (DTN file photo)

MT. JULIET, Tenn. (DTN) -- Kansas City Federal Reserve President Esther George said she thinks monetary policymakers will keep interest rates low and will continue buying Treasuries and mortgage-backed securities until there's more data on the myriad ways the economy is recovering from the pandemic.

George highlighted issues in the U.S. economy as inflation is growing faster than at any point over the past decade and is drawing increasing attention from policymakers.

"I see three big and somewhat sequential questions that policymakers will grapple with over the coming months," she told attendees on the first day of the Kansas City Fed's all-virtual 2021 Agricultural Symposium, emphasizing that there's no immediate answer to any of them, and they all play a role in what kind of inflationary environment evolves.

Consumers built their savings during the pandemic, leading to her first question: How quickly will they spend down their excess? She said the answer will be important in determining the general pace of growth in the economy over the next few years.

"While households could draw down their savings quickly, several factors suggest to me that people may want to hang on to at least a portion of that accumulated savings. Households are now painfully aware of new economic risks that might not have been a consideration a little over a year ago," she said.

One area of consumer behavior to watch is the trajectory of the housing market in the months and years ahead. Home prices, according to the S&P CoreLogic Case-Shiller Home Price Indices, surged 13% in March, on top of a 12% gain in February, some of the largest moves since 2013. Real estate brokerage firm Redfin said nearly half of all homes are selling above asking price.

"One of the questions is, will that cause people to sit back and say, 'I think I will wait and let those prices adjust?' Or will it be the dynamic we saw 50 years ago? Will people say, 'Oh, I'll buy now because I think they will go even higher.' I think it will take us a while to see how this economy sorts out," George said.

The next question -- will supply constraints impede growth? -- is a little more complicated. There are concerns about shortages of labor, raw materials and transportation services. As for labor, how quickly people return to work depends on pandemic-related factors, such as availability of childcare, enhanced unemployment benefits and fear of getting sick.

"As the pandemic fades and time passes, these factors will reverse labor constraints," she said, adding that some people, particularly those close to retirement, may have left the workforce entirely.

Some of the shortages of materials and transportation may be resolved yet this year, but other shortages will take much longer to work out. George pointed to the problems with computer chips as one area where recovery will take longer because there's a long lead time required to ramp up production.

The rapid shift in spending from services to goods during the pandemic led to a surge in imports backing up traffic in U.S. ports, which contributed to a global shortage of shipping containers. "A shift in consumption patterns back to services may help alleviate these delays, but it's not yet clear when that might occur," George said.

Increased productivity could help companies meet higher demand, but George said predicting evolution of different sectors can be difficult to forecast, especially because it develops unevenly across the economy. For example, restaurants became very productive -- measured by output per hour of work -- as they shifted to take out business, but that will likely change as consumers dine in. Other industries, like retail, adopted more self-checkout, which will likely be a more permanent increase to productivity.

"Let me turn to the third question, which is how will the dynamics of a strong economy and supply constraints affect inflation?" she said. Inflation over the last 12 months ending in April, which is measured by the Consumer Price Index, increased 4.2%, the fastest pace in a decade. She said many of the factors that boosted inflation over the past year will fade with time. What inflation looks like in the medium term -- the next three to 10 years -- is less certain.

For example, during the pandemic, the average price of a gallon of gasoline fell to $1.87. As of this April, demand has recovered as the economy reopened, and the average price of a gallon is $2.96, about equal to the average price over the last decade.

"Normalization in the price of gasoline contributed almost a percentage point to the overall rate of inflation," she said. Other industries that took big hits in the early pandemic, like air travel and hotel accommodations, saw prices rebound as well, which also contributed to inflation. "A normalization of prices depressed by the pandemic doesn't tell the whole story, though. Other sectors have seen prices jump far above pre-pandemic levels as supply constraints have developed against the backdrop of robust demand."

Automobiles are a good example because production disruptions have contributed to higher new-car prices, which has had even larger spillover effects in the used car and rental car markets.

"Those kinds of bottlenecks, though, seem likely to clear over time, and prices to stabilize. Expecting these price pressures to ease, however, does not ignore the potential for more persistent inflation pressures over the long term," George said. "It can be difficult to distinguish between a string of seemingly idiosyncratic bottlenecks and a broader-based lack of capacity. In the end, the persistence of any step-up in inflation will ultimately depend on the price and behavior of firms and workers."

The Federal Open Markets Committee, which determines monetary policy and of which George is a member, is paying close attention to inflation, especially since it adjusted its policy framework last year. Prior to the pandemic, prices didn't show signs of inflation despite the economy running near its capacity.

"As the economy works its way toward a new equilibrium, policymakers will be well served to take a flexible approach to monetary policy decisions, in my view," George said. But for now, she expects the present accommodative policy to continue.

Katie Dehlinger can be reached at katie.dehlinger@dtn.com

Follow her on Twitter at @KatieD_DTN


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