Full text of Econ Focus (Federal Reserve Bank of Richmond) : First/Second Quarter 2024, Volume 29, Number 1

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FEDERAL RESERVE BANK OF RICHMOND

FIRST/SECOND QUARTER 2024

The Outdoor
Recreation
Economy

Student Loans and
the Economy

Where the 2%
Target Came From

Interview with
Ulrike Malmendier

VOLUME 29 ■ NUMBER 1
FIRST/SECOND QUARTER 2024

Econ Focus is the economics
magazine of the Federal Reserve
Bank of Richmond. It covers
economic issues affecting the
Fifth Federal Reserve District
and the nation and is published
by the Bank’s Research Department.
The Fifth District consists of the
District of Columbia, Maryland,
North Carolina, South Carolina,
Virginia, and most of West Virginia.
DI R EC TO R O F P U B L ICATI ONS

Renee Haltom
EDI TO R

FEATURES

6 INVESTING IN THE GREAT OUTDOORS

Some rural and small-town communities see potential for outdoor recreation to
reinvigorate their economies

14 THE END OF THE STUDENT LOAN REPAYMENT
MORATORIUM

Borrowers didn’t have to make payments for three and a half years. How will they — and
the economy — weather a rapidly changing student loan landscape?

David A. Price
MA N AG IN G E D ITO R

Lisa Davis
STA F F WR ITE R S

Tim Sablik
Matthew Wells
EDI TO R IA L A SSO C IATE

Katrina Mullen

CON TR IB U TO R S
Carrie Cook
Simon Farbman
Charles Gerena
Thomas Lubik
Stephanie Norris
Alvaro Sánchez
Adam Scavette
Sam Louis Taylor
DESI G N

Janin/Cliff Design, Inc.
PUB L IS H E D BY
the Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261
www.richmondfed.org
www.twitter.com/RichFedResearch

DEPARTMENTS
1 PRESIDENT’S MESSAGE
A Forecasting Personality Test

2 RESEARCH SPOTLIGHT

Political Incentives for Sovereign Default

3 UPFRONT

New from the Richmond Fed’s Regional Matters Blog

4 AT THE RICHMOND FED

Collaborating to Improve Rural Access to Capital

5 POLICY UPDATE

Will Chevron Keep its Stripes?

10 FEDERAL RESERVE

The Origins of the 2 Percent Inflation Target

18 ECONOMIC HISTORY

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22 INTERVIEW

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Ulrike Malmendier on the Long-term Effects of Inflation and the Remembrance of Crises Past

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27 DISTRICT DIGEST

The views expressed in Econ Focus are those of
the contributors and not necessarily those of the
Federal Reserve Bank of Richmond or the Federal
Reserve System.

When Economists Navigate by the Stars

ISSN 2327-0241 (Print)
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Understanding SNAP’s Role

32 OPINION

Cover: Whitewater rafting on the New River, West Virginia.
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PRESIDENT’S MESSAGE

A Forecasting Personality Test

C

ontrary to most forecasts, including my own, the economy
finished 2023 strong. Inflation, as
measured by the personal consumption
expenditures price index, came down
all the way to 2.6 percent. At the same
time, despite higher interest rates,
global conflicts, and banking turmoil,
economic growth was healthy and
unemployment was near historic lows.
But early 2024 data has been a little
less easy to read, with inflation elevated
and consumer spending coming in
softer, while the labor market has
remained quite strong. So it’s easy to
see why people might differ on the path
forward for the economy — each forecaster sees the future through his or her
own lens. You likely do the same.
You might be an optimist, expecting inflation to return to our 2 percent
target while the economy stays healthy.
That could well happen: The extraordinary levels of post-pandemic spending have been normalizing. The painful
post-COVID-19 supply chain shortages
have been largely resolved. Immigration
and the rebound in prime-age labor
force participation have helped alleviate
labor market pressures, as have productivity increases. Most measures of inflation expectations suggest that businesses and consumers have found the
Fed’s inflation target credible.
There are also more pessimistic
cases to be made, generally falling into
three camps.
You might be a demand pessimist. You
might be concerned about the recent
increase in consumer delinquencies
and the challenges in commercial real
estate. You might worry about weakness in other interest-sensitive sectors as
well, like banking, residential real estate,
manufacturing, and home improvement.
You might note that nearly three-quarters of last year’s job gains came from
just three sectors — health care and
social assistance, leisure and hospitality,

and government — and worry that the
labor market might be nearing a turning
point. Or perhaps the risk of geopolitical
shocks keeps you up at night.
Alternatively, you might be an inflation pessimist. You might point to
continued strong wage growth in a tight
labor market. You might note consumers’ continued willingness to spend;
the saving rate is down to 3.6 percent
versus 7.7 percent pre-pandemic, and
that spending is potentially supporting higher prices. Or maybe you notice
other forces that arguably have turned
inflationary, from deglobalization to
limited housing supply to demographics
to energy transition.
Lastly, you might be a Fed pessimist.
You might fear the Fed will keep rates
too high for too long or normalize too
quickly and allow inflation to linger.
Our job isn’t easy, and history teaches
that most tightening cycles end poorly,
though often heavily influenced by an
outside event like the pandemic or the
1990 Gulf War.
What do I see?
On demand, I have to believe all of
this tightening will eventually slow the
economy further. After all, corporate

interest payments as a percent of corporate revenues and personal interest
payments as a percent of disposable
personal income have only now finally
gotten back in the range of 2019 levels
— suggesting the full impact of higher
rates is yet to come.
If the economy does cool, it doesn’t
need to be as painful as the Great
Recession. Employers who have fought
hard to recover from labor shortages tell me they are hesitant to lay
people off and run the risk of being
short again. And a slowdown shouldn’t
catch businesses by surprise; they’ve
already slowed hiring and streamlined
costs. Banks have cut back on marginal
credit. In short, the economy should be
less vulnerable.
On inflation, while I do hear
price-setters increasingly convinced that
the pandemic era of significant pricing power is behind them, the inflationary experience of the last two years
has surely given them more courage to use price as a lever. (See “How
the Pandemic Era Changed PriceSetting,” Econ Focus, Fourth Quarter
2023.) So I’m still looking for the slowing in reported inflation to sustain and
broaden.
Despite my concerns about demand
and inflation, perhaps it is no surprise
that I’m a Fed optimist, which is different than believing we are infallible.
I am optimistic that keeping rates
somewhat restrictive can bring inflation back to our target. While I don’t
see the economy overheating, the Fed
knows how to respond if it does. And if
the economy slows, the Fed has enough
firepower to support it as necessary.

Tom Barkin
President and Chief Executive Officer
econ focus

• first / second quarter • 2023 1

RESEARCH SPOTLIGHT
b y s i m o n fa r b m a n

Political Incentives for Sovereign Default
Marina Azzimonti and Nirvana
Mitra. “Political Constraints and
Sovereign Default.” Journal of
International Money and Finance,
October 2023, vol. 137, pp. 1-25.

I

n some countries, actors must
garner support from a wide swath
of the body politic in order to enact
policy. In others, national policy can
be enacted by smaller and less representative groups, with the extreme of
an absolute dictatorship. These differences among political systems can be
summarized as the extent to which the
country’s policymaking is bound by
“political constraints.” Naturally, these
constraints play a significant role in
shaping government policy.
In a recent article in the Journal
of International Money and Finance,
Richmond Fed economist Marina
Azzimonti and her co-author Nirvana
Mitra of the Reserve Bank of India
investigated the role that political
constraints play in a government’s
decision to default on its debts. To
do so, they developed a politicaleconomy model in which representatives of different groups with veto
power bargain over the nation’s taxes,
public spending, the level of international borrowing, and whether to
default on their current obligations.
They used this model to set on solid
theoretical ground the intuitive negative relationship between a country’s
degree of political constraints and its
probability of default.
The possibility of government default
sets their model apart from a standard political-economic model; while
many authors assume that governments will always honor their obligations, Azzimonti and Mitra sought
instead to investigate the circumstances in which governments may
find it optimal to instead default and
exit the credit market. Their model
allows for the political constraints of

2

econ focus

• first / second quarter • 2024

the model economy to vary from period
to period. In each period, the “minimum winning coalition” — defined
as the number of distinct representatives necessary to support a proposed
policy — is allowed to change. To enact
a policy beneficial to his or her constituents, a policy proposer will cobble
together a proposal with as few fellow
legislators as is constitutionally necessary, and to attract their support, the

The theoretical arguments and
empirical evidence amassed by
Azzimonti and Mitra suggest
that several distinct mechanisms
exist by which tighter political
constraints can reduce the risk of
sovereign default.
spoils of government are disproportionately expended on “pork” to the
participating groups. Hence, the larger
the current minimum winning coalition, the smaller the degree to which an
unrepresentative selection of the country benefits from government decisions.
Azzimonti and Mitra used this model
to identify three distinct theoretical
channels through which lower political constraints increase the probability of default. First, less constrained
governments will tend to overspend,
and thereby incur a larger debt burden.
Indeed, the smaller a governing coalition, the greater the relative benefit to
their constituents from issuing debt:
Borrowed resources are distributed
as largesse disproportionately to the
few groups with governing representatives, but the eventual cost of repaying the loan is borne by the nation as
a whole. For smaller coalitions, the
personal benefit will outweigh the cost,
leading to more spending, which ultimately increases the likelihood a future

government will have no choice but to
default.
Second, political constraints have a
more direct effect on a government’s
decision to default. When a government defaults, the resources previously
pledged to repay debt are released for
the government’s disposal, at the cost
of temporarily exiting the international
credit market. If the entire nation’s
well-being were to be considered, this
scenario would likely not be optimal.
Again, however, the released resources
are not to be spread equally to all citizens, but disproportionately to those
represented in the governing coalition. Hence, with a smaller minimum
winning coalition, each group in it gets
a larger piece of this pie, and so the
benefit to a representative from defaulting is more likely to outweigh the negative consequences of the country exiting the credit market.
This ties into the third and final
mechanism, a self-fulfilling prophecy
of sorts. Rational international lenders
are aware that less constrained governments will be more likely to default,
so they demand higher prices for their
debt to compensate for this risk. Hence,
policymakers’ behavior under loose
constraints makes the debt burden less
manageable, even if they are currently
behaving responsibly, and thereby may
make it more necessary to default in the
future.
The theoretical arguments and
empirical evidence amassed by
Azzimonti and Mitra suggest that
several distinct mechanisms exist by
which tighter political constraints can
reduce the risk of sovereign default.
Their work suggests that tighter political constraints can reduce the degree to
which a small segment of the country
can overspend national resources for
its own benefit, and in turn, reduce the
likelihood of the significant economic
and social trauma induced by a sovereign default. EF

UPFRONT
b y k at r i n a m u l l e n

New from the Richmond Fed’s Regional Matters blog
Jason Kosakow and Adam Scavette. “Are Fifth District Firms
Revisiting Their Prices Less Often Amid Cooling Inflation?”
Since inflation started to accelerate in 2021 and 2022, the Richmond
Fed’s monthly business surveys of Fifth District firms have paid
close attention to changes in firms’ realized prices and their pricing
expectations. Now that inflation has decelerated in the past year,
slowdowns have occurred in both realized and expected price growth
among those surveyed. For example, since
the start of the year, expected growth
rates have declined from 6 percent in early
2022 to 3.6 percent for services firms
and 1.6 percent for manufacturing firms.
Further, while services and manufacturing
firms differ in their expectations of
future price adjustments, the frequency
is expected to stay above pre-COVID-19
levels, highlighting the reality of pricing
uncertainty.
Adam Scavette and Sierra Latham.
“Unlocking Housing Supply: What Can
We Learn About Recent Construction and
Permitting Patterns in Our Region?”
Land availability and regulations can help
explain differences in local housing supply:
Fifth District counties with relatively high
housing supply growth also had relatively
high permitting rates. Regulations also play a role, as areas that are
more highly regulated (such as the Washington, D.C., region) tend to
have lower rates of new construction, while areas that are less regulated
(such as greater Charlotte, N.C.) tend to have higher rates. In Maryland,
two counties have had different experiences based on development
restrictions. Frederick County has a growing population and is considered
large by land area; it experienced growth of permitting and new housing
units above the national rate in 2021-2022. Talbot County, however,
considered small by land area, experienced little to no change in
population, with growth rates of permitting and new housing units well
below the national rates.
Laura Dawson Ullrich and Jacob Walker. “Non-Credit Workforce
Programs at Community Colleges.”
Non-credit programs are shorter than for-credit programs and typically
focus on skills and credentials related to specific occupational certifications,
such as a short-term welding certification or a commercial driver’s license.
Traditional data sources do not capture information on the scale of these
offerings or the outcomes of students enrolled. The Richmond Fed’s 2023

Survey of Community College Outcomes extended pilot surveyed 63
colleges across the Fifth District and determined that 154,340 students
were enrolled in non-credit programs. These students play an important
role in the total number of community college students across the Fifth
District — ranging from 76.2 percent of the student population at a small
rural school in Maryland to 8.8 percent at a school in West Virginia. Overall,
as more students shift to shorter-term credentials and employers become
more comfortable with these credentials,
better data collection will be key for
employers, community colleges, and students.
Jason Kosakow and Zach Edwards. “Is
Wage Growth Normalizing? What Fifth
District Businesses Are Saying About
Wages.”
Wage growth is above pre-COVID-19 levels
but has declined in recent months. Even
so, looking ahead, most firms expect wage
growth that is “about normal,” and they
anticipate a return to near pre-COVID-19
levels in the next 12 months. Moreover,
mentions by survey respondents of “worker
compensation,” which spiked to a high above
16 percent in 2021 during the COVID-19
labor shortages, remained elevated through
last year. Wage increases appear to be top
of mind for many Fifth District businesses,
including ones that have already increased wages to attract and retain
workers. For example, one business shared in a recent survey, "Payroll
inflation [put us in] the red in 2022, and we haven’t gotten everything
totally reconciled in 2023 ... if we raise our [prices] higher, people will just
go online and buy."
Adam Scavette and Keith Waters. “Urban Marylanders Are
Migrating to More Affordable and Smaller Metro Areas.”
In December, Maryland’s unemployment rate reached nearly 2 percent,
indicating the state’s tight labor market and ongoing hiring challenges
amid a slow post-pandemic labor force recovery. An increasing number
of Maryland residents are leaving the state entirely: In 2021 and 2022,
Maryland experienced the highest net domestic out-migration in the Fifth
District at -25,641, and -65,622 people, respectively. Much of the state’s
net domestic out-migration before the COVID-19 pandemic was from the
Washington-Baltimore corridor to affordable, large metro areas. During the
pandemic, however, destinations shifted toward midsized and small metros
and rural areas; in 2023, migration to such areas continued to surpass 2019
levels. EF
econ focus

• first / second quarter • 2024 3

AT THE RICHMOND FED
by charles gerena

Collaborating to Improve Rural
Access to Capital

S

mall towns and rural communities play a key role in
the Fifth District’s economy. Not only do they make up
nearly one-quarter of the region, they also have important economic ties to neighboring cities and counties.
That’s why the Richmond Fed is addressing the economic
health of rural areas as part of its broader mission of
strengthening the economy. Working with partners on the
local, regional, and national levels, the Bank’s Community
Development team recently launched the Rural Investment
Collaborative to increase economic investment in small
towns and rural communities throughout the Fifth
District.
“When we spoke to rural leaders, they let us know they
wanted to work together on improving access to capital,”
says Jason Smith, senior community development advisor at the Richmond Fed. Smith leads the Rural Investment
Collaborative for the Bank. “Increased workforce training is
important, but without community and economic development investment, the people who develop new skills may go
to where there are resources to use them.”
The Rural Investment Collaborative aims to address
demand and supply issues that impede access to capital in
rural areas. On the demand side, the collaborative identified a lack of expertise in applying for funds as an obstacle.
“Small towns and rural communities have fewer organizations and individual leaders who have the time and skills to
pursue community and economic development investments,”
notes Smith.
On the supply side, the collaborative recognized two
issues. First, there are fewer sources of capital in small
towns and rural communities. According to Smith, because
many rural areas have higher percentages of low- and
moderate-income people, “there are fewer local resources
in the form of a tax base and philanthropic capital to help
secure investments.”
Second, there is a lack of coordination of capital sources
for rural investment that do exist. “Money rarely comes
from a single funding source for today’s projects,” says
Jarrod Elwell, the Richmond Fed’s community development regional manager for Virginia and Washington, D.C.
“Instead, funding typically involves multiple sources and
entities, both public and private.”
For example, a subsidized housing developer told Elwell
last year that one project had 23 different funding sources.
Each source can have its own application process, use
restrictions, and reporting requirements, so aligning the
layers of this “capital stack” takes time. Elwell has learned
4

econ focus

• first / second quarter • 2024

that it can take between seven and nine years for a project in
a rural area to go from conception to completion.
To improve the demand side of the capital equation, the
Richmond Fed worked with Invest Appalachia to create
the Community Investment Training program. The Rural
Investment Collaborative’s eight-member steering group and
a project development workgroup selected 20 rural leaders from nonprofits and government agencies in the Fifth
District to learn the basics of community development
finance and expand their network. The objective is for each
participant to develop and pitch a proposal for a real-life
project at the end of the 12-week virtual program. To help
build a coalition of local support for their projects, participants will also receive a $2,000 mini-grant from the collaborative’s partners.
Richmond Fed staff did not participate in the fundraising for the grants or selecting the grantees or the participants. Instead, they relied on people on the ground like
Jennifer Hudson, development director of the Williamson
Health and Wellness Center in West Virginia. Hudson
joined a pilot version of the training program because she
wanted to gain the skills to communicate and move her
ideas forward.
“It’s all about relationships,” describes Hudson. “I’ve
been able to share resources and to be part of a team working to secure funding for projects that inspire us.” So far,
the connections she made through the training have led
to support for several projects, including the reopening of
a rural hospital and the launch of an indoor market and
kitchen in Williamson.
To address the supply of capital in small towns and rural
communities, the Richmond Fed has been bringing together
leaders with expertise in community development financing. In May 2023, the Bank gathered practitioners, funders,
and researchers from organizations including Harvest
Foundation, United Way of Southwest Virginia, Invest
Appalachia, Claude Worthington Benedum Foundation,
Brookings Institution, Bloomberg Philanthropies, and the
Annie E. Casey Foundation. This group helped develop a
work plan for a new capital development workgroup within
the Rural Investment Collaborative.
The workgroup members met this past February. Led
by Elwell, they began to develop research questions and
resources for rural leaders. Ultimately, their work will help
inform decision-makers about the challenges, opportunities,
and promising practices related to improving capital access
for small towns and rural communities. EF

POLICY UPDATE
b y s a m l o u i s tay l o r

Will Chevron Keep its Stripes?

F

ollowing the will of Congress
is often a complicated endeavor
for regulators, especially when
lawmakers leave aspects of a regulatory law unclear. That uncertainty
often leads to litigation. But how
should courts determine if an administrative agency has gone outside the
bounds of the law when designing
regulations? This is an important question for regulators, like the Fed, that
have been charged with implementing
laws passed by Congress.
In the 1984 landmark case Chevron
U.S.A., Inc. v. Natural Resources
Defense Council, Inc. the court established a process to determine whether
an agency has acted properly in creating a regulation in the face of legislative uncertainty. This concept,
commonly referred to as Chevron
deference, has been a critical legal
concept that has governed how courts
oversee the regulatory process for the
past 40 years. In January, the Supreme
Court heard arguments in two cases
that could overturn Chevron and set
out new expectations for how agencies should implement laws passed by
Congress.
In Chevron, the Supreme Court
established a two-part test to determine the lawfulness of a regulation. First, when a regulation is being
challenged, a court will determine if
Congress has spoken clearly on the
matter. “If the intent of Congress is
clear, that is the end of the matter.” But
if Congress does not clearly state how
it wants a statute to be implemented,
then courts should defer to an agency’s interpretation of the statue that
is within its administration so long as
it is a “permissible construction” of
the law. The court based this deference on three reasons: ambiguity in a
statute amounts to an implicit delegation of authority by Congress to an
agency to resolve outstanding questions of implementation; an agency has

greater subject matter expertise than
courts to resolve this ambiguity; and
an executive branch agency is a better
venue for reconciling “competing political interests” than the courts because
the president has greater political
accountability.

In the 1984 landmark case
Chevron U.S.A., Inc. v. Natural
Resources Defense Council,
Inc. the court established a
process to determine whether
an agency has acted properly in
creating a regulation in the face
of legislative uncertainty. This
concept, commonly referred to
as Chevron deference, has been
a critical legal concept that has
governed how courts oversee the
regulatory process for the past
40 years.
The Supreme Court has combined
two cases in its current term,
Relentless, Inc. v. Department of
Commerce and Loper Bright Enterprises
v. Raimondo, in which two herring fishing companies have challenged a rule
from the National Marine Fisheries
Service that requires the industry to
pay for on-board observers to monitor federal conservation efforts. Lower
courts cited Chevron in rejecting the
companies’ challenges. The petitioners
have asked the Supreme Court to overrule Chevron or at least significantly
curtail the deference given to agency
determinations.
What would be the impact of ruling
against the government in these
cases? Legal scholars have predicted
that agencies could become more
constrained in their interpretations of
statutes and more hesitant to create

regulations in response to new and
emerging issues without going to
Congress for more authority. Experts
have also observed that Congress
would need to clearly state its intent
when drafting laws or be willing to
come back and tackle new issues as
they arise. There are also predictions
that regulations would more often be
challenged in court because agencies
could not count on judicial deference to
their interpretations of statutes.
There are many in the political and
legal sphere who see these potential
changes as a feature, not a drawback,
of overturning Chevron. In an amicus
brief led by Sen. Ted Cruz, R-Texas,
Republican members of Congress have
argued that Chevron has inappropriately expanded the role of agencies into
policymaking, a power reserved for
Congress.
“Over time, it’s proven to be a harmful precedent because it shifts decision making away from democratically
elected members of Congress to the
permanent members of the bureaucracy,” the Republican members of
Congress argued.
Others have argued that Congress
purposefully provided agencies with
leeway to respond to new threats that
it could not have anticipated. A brief
filed by Sen. Sheldon Whitehouse,
D-R.I., on behalf of a group of Senate
Democrats stated, “As industries grew
more complex, Congress delegated
some regulatory authority to administrative agencies. Chevron deference
has been an important element in this
endeavor, allowing Congress to rely
on agency capacity and subject matter
expertise to help carry out Congress’s
broad policy objectives.”
Regulators and other interested
parties will be following the ruling
closely to better understand the
limits courts are likely to impose
on the way agencies operate in the
future. EF
econ focus

• first / second quarter • 2024 5

The Virginia Capital Trail spans almost 52 miles
from Richmond, Va., to Jamestown, Va.
In 2018-2019, visitors to the trail spent an
estimated $6.1 million in the state.

Investing in the Great Outdoors
Some rural and small-town communities see potential for
outdoor recreation to reinvigorate their economies
BY TIM SABLIK

6

econ focus

• first / second quarter • 2024

work has reduced the importance of proximity to employers when choosing where to live, making a place’s outdoor
amenities even more significant. But is investing in outdoor
recreation a good strategy for a community’s long-term
economic growth?
UNTAPPED POTENTIAL
In 2022, according to the U.S. Bureau of Economic Analysis
(BEA), the value added from the outdoor recreation economy accounted for 2.2 percent — $563.7 billion — of the U.S.
gross domestic product (GDP). Compared to the economy
as a whole, the outdoor recreation sector experienced rapid
growth in recent years. Inflation-adjusted, or real, GDP for
the outdoor recreation sector increased 4.8 percent in 2022
(the latest data available), down from an astonishing 22.7
percent growth in 2021 but still greater than the overall U.S.
economy’s growth of 1.9 percent.
The BEA divides the outdoor recreation economy into
three broad categories: conventional activities, which
includes things like cycling, boating, and hiking; other activities, such as gardening or outdoor concerts; and supporting

i m ag e : j ess p e te rs

W

hile the appeal of Mother Nature has always
been self-evident to enthusiasts, the COVID19 pandemic brought in new converts. Once it
became clear that the virus spread less easily in open
spaces, and with many indoor options shut down, outdoor
recreation became a compelling option for anyone looking
to escape their home or apartment in 2020.
In addition to visiting state parks and trails in record
numbers, many Americans moved from cities to suburbs,
small towns, and rural places in search of more open spaces.
According to a March 2023 report from Harvard University’s
Joint Center for Housing Studies, change-of-address requests
through the U.S. Postal Service were 22 percent higher in
March 2020 compared to a year earlier, and 14 percent
higher in April 2020 than in April 2019. States that gained
from domestic migration in 2020-2021 included places with
desirable climates and outdoor recreation opportunities, such
as the Sun Belt and the Mountain West.
Even before 2020, there was evidence that natural amenities and the general quality of life in a community were
important factors in people’s decisions to visit or move to a
place. Many believe that the pandemic and the rise in remote

Outdoor Recreation Economy Growth in the Post-Pandemic Era
GDP Value Added in Fifth District States

PERCENT CHANGE FROM A YEAR AGO

activities, such as construction and
travel and tourism. This last category
50
accounted for nearly half of the value
40
added from outdoor recreation in 2022
30
at 46 percent. A big part of that support20
ing activity is tourism. The arts, enter10
tainment, recreation, accommodation,
0
and food services industry generated
about a quarter of the overall national
-10
value added by outdoor recreation, or
-20
$144.5 billion.
-30
While some states have always
-40
attracted tourists with their outdoor
-50
offerings, the COVID-19 pandemic
-60
spurred many people to explore options
2018
2019
2020
2021
2022
closer to home. In Virginia, state parks
NC
DC
MD
SC
VA
WV
saw roughly a million more visitors
in 2020 than in 2019. That traffic has
NOTE: Statistics isolate the economic activity associated with outdoor recreation spending and production in a state's economy.
not slowed down, even as more wideSOURCE: U.S. Bureau of Economic Analysis, Outdoor Recreation Satellite Account
spread travel has opened up. According
to a recent presentation to the Virginia
Senate Finance and Appropriations Committee by Virginia
restaurants, stores, restrooms, campsites, lodging, and bicycle
Department of Conservation and Recreation Director
repair stations. A 2019 economic impact study conducted by
Matthew Wells, the state’s parks had just over 8 million
the University of Richmond in partnership with the Institute
visitors in 2023 compared to 6.9 million in 2019. From
for Service Research found that visitors to the Virginia Capital
2017 to 2019, outdoor recreation consistently contributed
Trail in 2018-2019 spent an estimated $6.1 million in the state,
between $9 billion and $10 billion annually to the Virginia
mostly within a 50-mile radius of the trail.
economy. In 2022, that amount grew to $11.35 billion, or
1.7 percent of the state’s GDP. (See chart.)
ATTRACTING NEWCOMERS
Capturing those economic benefits, particularly from visitors, takes careful planning. Many outdoor recreation activTourism is just one important way communities can leverage
ities take place in public spaces that may be maintained
the economic potential of the outdoors. Some of those visitors
through local taxes. But by their open public nature, those
may turn into long-term residents.
spaces can be accessible to non-taxpaying visitors as well.
“Tourism is the red carpet to residency,” says Danny Twilley,
“You need to design fiscal policies to capture some of
assistant vice president of economic, community and asset
the economic activity from visitors to invest locally in
development for West Virginia University’s Brad and Alys
order to sustain a strategy around outdoor recreation,” says
Smith Outdoor Economic Development Collaborative (OEDC).
Santiago Pinto, a senior economist and policy advisor at the
Utilizing the university’s intellectual and social capital, the
Richmond Fed whose research includes studying regional
Smith OEDC helps communities in the state leverage their
economics.
outdoor assets to improve their economy and quality of life.
In its Rural Economic Development Toolkit, the Outdoor
There are many factors that people consider when decidRecreation Roundtable (ORR), a national business coalition
ing where to live, including the job or business environment
that promotes outdoor recreation activities, advises commuand the community’s quality of life. Economists define quality
nities on how to capture the value from outdoor tourism.
of life by the various amenities a community offers residents
That includes charging fees for out-of-state visitors to parks
and measure it by how much households are willing to pay in
or making use of overnight lodging taxes. Communities are
terms of higher housing prices or lower wages to gain access
also encouraged to think about the entire network of busito those amenities. Some types of amenities are generated by
nesses that could surround outdoor recreation destinations,
density, such as the availability of restaurants and cultural
such as restaurants, breweries, outfitters, and hotels.
events in densely populated cities, while outdoor ameni“The places that have been most effective at building an
ties are naturally occurring and are often enhanced by lower
outdoor recreation economy are thinking about the whole
population density.
value chain,” says Chris Perkins, vice president of programs
In the case of rural and small towns, there is growing
at the ORR. “From the moment someone enters to pursue an
evidence that outdoor recreation can be a significant driver
outdoor recreation opportunity, they’re receiving marketing
for in-migration. A 2019 paper by Headwaters Economics, a
about all the community amenities.”
nonprofit research group focused on community development
The Virginia Capital Trail, a nearly 52-mile-long paved
and land management, found that between 2010 and 2016,
path for walking and biking that follows the James River from
micropolitan counties (places with at least one urban area with
Richmond to Jamestown, is one example of this approach.
between 10,000 and 50,000 residents) lost an average of 15.6
Along the trail, which is free to access, visitors can find
residents per 1,000 if their economy wasn’t focused on outdoor
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• first / second quarter • 2024 7

recreation. But recreation-based micropolitan counties gained
an average 21.6 residents per 1,000 over the same period.
Nonrecreational rural counties lost 19.9 residents per 1,000,
while recreation-based rural counties gained 1.3 residents per
1,000. (Rural counties are defined as ones that don’t have an
urban area with at least 10,000 residents.)
Historically, the advice for rural and small towns looking
to grow has been to focus on improving the business environment to attract job-generating firms. In a recent Richmond
Fed Economic Brief, Pinto documented that the evidence on
the effectiveness of such incentives has been mixed. Placebased policies to attract firms can reduce poverty and increase
employment, but they can also push existing residents out and
create negative spillovers on surrounding localities.
More recently, researchers have been investigating whether
investments in a community’s quality of life, such as outdoor
recreation, could be part of an effective and sustainable growth
strategy. In a 2023 article in the Annals of Regional Science,
Amanda Weinstein of the Center on Rural Innovation and
Michael Hicks and Emily Wornell of Ball State University
found that quality of life was more important to the success
of micropolitan areas than the business environment. Having
a higher quality of life was associated with greater population growth, higher employment, and lower poverty rates.
The COVID-19 pandemic reinforced these trends, as many
Americans moved from dense cities to more open spaces. (See
“Paid to Relocate,” Econ Focus, Third Quarter 2022.)
“COVID was traumatic in so many ways, but one thing it
did was make us all stop what we were doing and take time
to revisit what’s important to us,” says Andrew Williamson,
director of outdoor economic and community development
for the Smith OEDC. “Many people rediscovered an appreciation for being outdoors, whether it’s a local park or the
wilderness in the backcountry. You couple that with the ability to now live and work from anywhere, now West Virginia
has a huge opportunity.”
DIVERSIFYING THE LOCAL ECONOMY
For decades, West Virginia’s economy has relied heavily on
resource extraction, chiefly coal. Energy extraction jobs often
pay very well, but the industry is subject to economic booms
and busts. (See “Navigating Energy Booms and Busts,” Econ
Focus, Fourth Quarter 2018.) Now, economic development
organizations like the Smith OEDC are exploring whether
investments in outdoor recreation could help extraction-based
communities build more diverse, less volatile economies.
“We believe that when you invest in people and you invest
in place, the companies may come and go, but the people in
the community will stay,” says Twilley. “For me, this is the
most important thing we could ever do for West Virginia,
because they’ve seen the extraction of resources and how
when companies downsize or leave, jobs leave, then people
leave. Investing in community and the outdoor economy can
help stabilize that trend.”
Both Twilley and Williamson stress that this strategy is
not a quick fix. It can take many years for investments in
outdoor recreation and the surrounding community to bear
fruit. A recent report from Headwaters Economics exploring
8

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• first / second quarter • 2024

the use of outdoor recreation to diversify the economy of
resource-dependent communities also emphasized the
importance of setting realistic expectations.
“Jobs in the resource extraction industries tend to be
high-paying,” Michael Tolan, the report’s author, wrote. “It is
not reasonable to expect outdoor recreation to ‘replace’ these
jobs overnight.”
Still, jobs in the outdoor recreation industry are growing
fast. According to the latest BEA data, both outdoor recreation employment and compensation increased by a higher
percentage in 2022 than the U.S. economy overall. Outdoor
recreation employed nearly 5 million workers, 3.2 percent of
the overall workforce, in 2022. But will the jobs and activities that support outdoor recreation necessarily facilitate the
development of a dynamic and innovative local economy?
That remains to be seen.
“The people who are attracted to a place because of its
outdoor amenities may or may not bring entrepreneurial
skills and ideas to the area,” says Pinto. “Nonetheless, the
resulting population inflows may create a ripple effect, stimulating the local development of outdoor-related businesses
and other complementary activities and services.”
WHAT DOES IT TAKE TO SUCCEED?
First and foremost, a community looking to develop its
outdoor recreation economy needs to have some outdoor
amenities to work with. Sometimes this can mean taking a
fresh look at features that have long been there. For example,
the New River Gorge in West Virginia was designated as a
national river in 1978, and locals had long taken advantage of
the opportunities it offered for hiking, climbing, and rafting.
In 2021, it became the country’s newest national park, and
some saw an opportunity to do more.
Corey Lilly, a 10th generation West Virginian and outdoor
enthusiast who competed professionally across the country
as a skier and kayaker, returned to his hometown of Beckley
to head up its office of outdoor economic development. Like
many communities in the state, the city of Beckley (population of around 16,000) was known for coal mining. Its proximity to the new national park presented an opportunity to
reinvent itself as an outdoor recreation destination. With
Lilly’s leadership, the community has launched the Beckley
Outdoors plan with the goal of establishing the city as “a
premier outdoor destination that celebrates southern West
Virginia’s Appalachian heritage.”
Having a local community champion like Lilly is a necessary ingredient for building up an outdoor recreation economy, according to the ORR’s Perkins.
“Ideally, they are someone who has the respect of a wide
variety of stakeholders within a community,” he says. “They
are willing to show up to the town council or community
commissioner meeting to build relationships and make the
case for the project. That can’t be parachuted in from the
outside. It’s community-level relationships that make this
happen.”
In addition to building local buy-in, it can also be helpful
to have coordination and support at the state, regional, and
national levels. Environmental conservationists and outdoor

recreation advocates in Virginia joined forces to form the
Our Virginia Outdoors coalition in 2021, which advocates
for dedicated, consistent state funding for natural resources.
Such funding would both help preserve those resources for
future generations and better capitalize on the economic
potential of outdoor recreation.
“Virginia has 42 state parks and 66 natural area preserves,
a good portion of which are open to the public. And yet,
when you look at the state budget and ask whether we are
putting money toward this as a priority, the answer is a
resounding ‘no,’” says Mikaela Ruiz-Ramón, the public funding and policy manager for the Virginia chapter of the Nature
Conservancy, a global nonprofit environmental group.
The Virginia Department of Conservation and Recreation
reports that state parks alone have accumulated a roughly
$300 million backlog of deferred maintenance. This includes
projects like improving the accessibility of parks, repairing
and modernizing campgrounds and other facilities, and maintaining trails, roads, and bridges.
“There is so much demand for programming and overnight stays at state parks that isn’t met because money hasn’t
consistently been put in for cabins, camping facilities, and
other basic utilities like electricity, plumbing, and roads in
and out of the parks,” says Ruiz-Ramón.
Nationally, 21 states have established offices of outdoor
recreation to guide investments in outdoor resources and
improve state competitiveness for funding and talent. In the
Fifth District, North Carolina, Virginia, and Maryland have
offices of outdoor recreation, all of them established in the
past seven years. Many of these offices also work together to
share best practices.
“If you’re biking or paddling down a river, you’re not
paying attention to state lines,” says Ruiz-Ramón. “It’s a
collaborative space because of the nature of the business.”
The Confluence of States, managed by Maribel Castañeda,
is a bipartisan coalition of 17 states dedicated to growing
the outdoor recreation sector. North Carolina was a charter
member when the coalition formed in 2018; Virginia joined
in 2019, and Maryland in 2022. Members agree to support
common principles around conservation and stewardship,
education and workforce training, economic development,
and public health and wellness.
“We’re in competition with each other, but at the end of
the day, we all know how important outdoor recreation is for
every state,” says Castañeda.
The Appalachian Regional Commission (ARC) is a federal-state partnership established in 1965 to strengthen the
economy of the region, which includes all of West Virginia
and parts of Maryland, Virginia, North Carolina, and South
Carolina. (For more on the history of ARC, see “Connecting
a Region Apart,” Econ Focus, Second Quarter 2022.) One of
ARC’s current investment priorities is enhancing the regional

culture and tourism of the counties it serves, including
through outdoor recreation. ARC funding helped St. Paul, a
former coal and railroad community in southwest Virginia
with a population of under 1,000 people, develop outdoor
recreation and tourism opportunities centered on the Clinch
River that runs alongside its downtown.
SUSTAINABLE DEMAND?
In the case of some communities, their proximity to natural
amenities for outdoor recreation can also create challenges
for building the infrastructure needed to support visitors and
new residents. In a 2021 report, the Urban Institute noted
that rural communities situated near state or national parks
often lack services such as banks, health care facilities, public
libraries, schools, and transportation compared to other
communities. The wide open spaces needed for outdoor
recreation can limit the land available for building, which can
put pressure on housing prices as a community grows. And
when it comes to housing, the goals of increasing tourism
and residency can be in conflict, with an influx of tourists
leading to an uptick in second homes and short-term rentals
that price out residents.
“Oftentimes communities are so eager to attract external
investment that they try to be everything to everyone, and
they forget about their core stakeholders, which are their
local community and workforce,” says Perkins. “It’s important to plan ahead and find the right balance between bringing in people from the outside and investing locally to grow
at a sustainable rate.”
Communities considering reorienting their local economy
around the outdoors may also wonder if the surge in demand
for fresh air brought about by the pandemic will persist long
enough for such a development strategy to pay off. While no
one can predict the future, there are some indications that
the ways we live and work have shifted in lasting ways.
The prevalence of working from home has come down
from the highs seen in the spring of 2020, and workers are
returning to the office, but the share of days worked from
home remains well above pre-pandemic levels as many
workplaces have settled into a hybrid schedule. Many parks,
such as those in Virginia, continue to report record attendance. The increasing number of states establishing offices of
outdoor recreation demonstrates a growing commitment to
investing in natural amenities. And health care professionals
are increasingly touting the mental and physical health benefits of being outside.
“Taking a walk outside has only ever made me feel better
than before I started, and I think more people are recognizing the same thing,” says Perkins. “That bodes well for
this generation to be long-term recreation participants and
advocates.” EF

READINGS
“Recreation Counties Attracting New Residents and Higher
Incomes.” Headwaters Economics, January 2019.
Tolan, Michael. “Outdoor Recreation & Economic Diversification in
Resource-Dependent Communities.” Headwaters Economics, 2022.

Weinstein, Amanda L., Michael Hicks, and Emily Wornell. “An
Aggregate Approach to Estimating Quality of Life in Micropolitan
Areas.” The Annals of Regional Science, 2023, vol. 70, pp. 447-476.

econ focus

• first / second quarter • 2024 9

FEDERAL RESERVE
b y m at t h e w w e l l s

The Origins of the 2 Percent
Inflation Target
The Fed established an explicit inflation target in 2012, but the internal debate
began decades before
“The Committee seeks to achieve
maximum employment and inflation
at the rate of 2 percent over the longer
run.”

E

ight times a year, the Federal Open
Market Committee (FOMC) meets
to conduct monetary policy, and,
regardless of what actions it takes, this
seemingly straightforward line has
appeared in each of its post-meeting
statements since September 2020. By
now, many Fed watchers may take it
for granted.
But the committee — the Federal
Reserve Board’s seven governors,
the president of the New York Fed,
and a rotating set of four presidents
from the other Reserve Banks — has
not always been so transparent and
precise on this subject. For decades,
it did not aim for a target inflation number; even when it appeared
to settle behind the scenes on a 2
percent target in 1996, it wasn’t made
public and explicit until 2012 – 16
years later.
The 2012 pronouncement was the
result of a decades-long deliberation,
as members first raised the issue in
the mid-1990s. Policy change moved
slowly, however, as committee turnover brought new preferences and
ideas into a dynamic economic and
political environment. Along the way,
the Richmond Fed’s leadership played
an important role in bringing these
changes about, from being among the
first to raise the idea of a target to
providing the intellectual leadership
that shaped discourse about the benefits of a public inflation target for price
stability.
10

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• first / second quarter • 2024

RAISING THE ISSUE IN THE 1990s
Price stability has long been a primary
focus of the Fed, even before it was
officially established as a part of the
Fed’s mandate in the Federal Reserve
Reform Act of 1977. Despite this focus,
the Fed was not always successful, and
inflation would hover near or above
double digits throughout the 1970s.
Paul Volcker, the staunch inflation
hawk who became chair of the Fed
in 1979, largely succeeded in bringing inflation under control; it was
down to 3.2 percent by the end of 1983.
The sharp increases in interest rates
he used to get there were politically
unpopular and led to a deep recession,
but they showed the Fed could indeed
control the trajectory of inflation
through monetary policy.
At the time, most policymakers did
not see a need for a target inflation
rate; they just knew inflation was too
high. Many held that view up until
the mid-1990s. Al Broaddus was president of the Richmond Fed at the
time, and he agreed the rate needed
to come down. More importantly,
though, he also maintained the Fed’s
credibility rested not only in managing actual inflation, but also in its ability to shape inflation expectations. It
could establish credibility through a
policy of “preemption” — increasing
interest rates in response to increasing inflation expectations rather than
actual inflation. But on its own, such
a policy wasn’t necessarily sufficient
for establishing long-term price stability, according to Broaddus. “Among
monetary economists, there was an
increasing recognition that something

else was needed,” he says. “So people
started talking about inflation targets.”
Inflation was 2.8 percent when the
FOMC held its July 1994 meeting.
While it had come down from higher
levels, Thomas Melzer, then president of the St. Louis Fed, was still
concerned that markets were uncertain about the Fed’s ultimate aims,
prompting him to raise the idea of a
target. “If we don’t make an explicit
statement .… that goes beyond ‘we
think price stability is good,’” he
argued, “and get more specific in terms
of a target range, then at the very
least I think we have to make it clear
that we consider 3 percent inflation
to be unacceptable.” Broaddus agreed,
suggesting the committee should take
the “opportunity to make our longerterm goals more explicit with respect
to prices and tie ourselves down a bit.”
Other FOMC members were skeptical,
suggesting such an idea would be difficult to put into actual policy.
A formal debate on the topic would
take place in the committee the following January. Chair Alan Greenspan
took over from Volcker in 1987 and
tasked Broaddus with arguing for the
pro-targeting position at that month’s
meeting; Janet Yellen, appointed a
governor in August 1994, was tapped
to present arguments in opposition.
(Yellen became president of the San
Francisco Fed in 2004, Fed chair in
2014, and Treasury secretary in 2021.)
Broaddus urged the committee to
move “away from the almost purely
discretionary approach to policy we
have followed historically ... toward an
approach where the central focus would
be on precommitment to a permanent

Volatility to Moderation
Core PCE Inflation over Time
12
PERCENT CHANGE FROM QUARTER
ONE YEAR AGO

low inflation objective.” He outlined
several advantages to what has come to
be known as “flexible inflation targeting,” including that it would allow the
committee to pursue more activist
policy in the short run without losing
long-term credibility. For example,
the FOMC might find it necessary to
temporarily cut interest rates — thereby
boosting inflation — to move against
short-term dips in economic activity, but the public need not change its
expectations if it knew inflation would
return to the target in the medium to
longer term. Broaddus also noted some
other countries were moving in the
direction of an inflation target, and
the United States should also want to
signal its commitment to locking in low
inflation. Broaddus didn’t name the
countries he had in mind, but Canada
and New Zealand were two that had
adopted an inflation target by this time.
Yellen, who would develop a reputation as perennially the most prepared
person in any room, with a thick binder
of notes and her own dashboard of
economic indicators, made the case that
controlling the inflation rate should not
be the only objective; she argued that
the Fed’s other legislatively mandated
goal — maximum employment — was
also important for a strong and stable
economy. Sensing that an inflation
target would lead monetary policy to
prioritize inflation over employment,
she suggested that if the Fed were to
adopt any rule, it should pursue a hybrid
one similar to those that seemed to be
used by other central banks, such as the
German Bundesbank, where monetary
policy was adjusted on the basis of two
targets: inflation and economic output.
At the conclusion of the discussion,
Greenspan sensed the committee was
split, and no action was taken.
Eighteen months later, in July 1996,
the FOMC again revisited the issue.
Yellen still expressed concern about the
potential adverse effects of low inflation
on employment, but, in a signal that her
thinking had evolved, she spoke in favor
of keeping the inflation rate below 3
percent and argued they should work to

10
8
6
4
2
0

1970

1975

1980

1985

1990

1995

2000 2005

2010

2015

2020

SOURCE: U.S. Bureau of Economic Analysis
NOTE: Core PCE (Personal Consumption Index) is a measure of prices paid for goods and services. Core PCE eliminates prices for
food and energy, which can have significant and more frequent price fluctuations.

eventually bring it down to 2 percent, a
number that appeared to be supported
by a strong majority of the committee,
including Broaddus.
THE ERA OF THE IMPLICIT TARGET?
Because he believed in keeping the
committee’s monetary policy decisions confidential, market watchers over the course of Greenspan’s
nearly two decades as chair went so
far as to analyze the size of his briefcase on FOMC meeting days for some
sort of signal as to whether he would
push for an interest rate cut. In keeping with that predisposition toward
secrecy, at one point in the July 1996
discussion, after the committee seemed
to settle on 2 percent, Greenspan
reminded members of their obligation
not to disclose any decisions it might
reach regarding the inflation target.
With an eye on potential political and
market blowback, he warned, “I will
tell you that if the 2 percent inflation
figure gets out of this room, it is going
to create more problems for us than I
think any of you might anticipate.”
Don Kohn, who served as director of
the monetary affairs division at the Fed
during this period, was in the room. He
offers two explanations for Greenspan’s
reluctance to go public with the target.

First, he posits Greenspan simply did
not want his discretion constrained
in any way when it came to possible
actions he might want to take. Second,
there was “an unwillingness to create
an output gap to get to 2 percent”
during the periods when inflation was
above that, says Kohn. “If you make 2
percent public, and you’re running at 2.5
percent, then the question is, ‘why aren’t
you creating unemployment to get to 2
percent?’ That’s not a position anyone
really wanted to be in.” At that time,
the FOMC saw itself as being able to
bring inflation down successfully without deliberately raising unemployment
in what has been described as “opportunistic disinflation;” those are disinflations caused by other forces in the
economy but consolidated into place by
monetary policy once they occur. After
the early and mid-1990s, inflation did
fall without a Fed-caused recession or
seriously impinging on policy flexibility:
Inflation measured by the core personal
consumption expenditures (PCE) index
went from between 3.5 percent and
5 percent in the late 1980s and early
1990s to largely between 1 percent and
2 percent from the mid-1990s until the
late 2010s. (See chart.)
Marvin Goodfriend was Al
Broaddus’ primary adviser and the
Richmond Fed’s research director.
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• first / second quarter • 2024 11

FE DE R AL R E S E RVE

Prior to becoming an economist, he
had spent a year trying to make it as a
rock musician living in a friend’s Los
Angeles garage, and he had kept that
musician’s independent spirit, holding fast to the idea the target should
be explicit and known by the public
at a time when the idea was considered highly unorthodox. He had long
argued for transparency regarding the Fed’s goals and intentions
because without it, its actions to stabilize real economic activity and financial markets were not credible and left
open to misinterpretations by market
and economic participants.
“Marvin was among the earliest to
conclude that an inflation target would
help the Fed achieve this credibility,”
says Broaddus. “His influence on my
thinking about a target was decisive
and provided the foundation of our
advocacy in the FOMC.” (Goodfriend
later served on the faculty of Carnegie
Mellon University; he passed away in
2019.)
In an October 2003 speech Ben
Bernanke gave at the St. Louis Fed —
he was then a little over a year into
his three-year tenure as a member of
the Board of Governors — he shared
Goodfriend’s skepticism that the public
and financial markets understood
the Fed’s implicit inflation objective.
Announcing a target, what he called the
optimal long-run inflation rate (OLIR),
was crucial because it “should help
participants in financial markets price
long-term bonds and other financial
assets more efficiently; help to lower
inflation risk in financial markets and
in other forms of contracting; and tend
to stabilize long-term inflation expectations more broadly, which in turn
would make short-run stabilization
policy more effective.”
Bernanke also took the important
step of explaining why the OLIR was
2 percent. His argument centered on
the ability of policymakers to boost
economic activity through interest
rate cuts during periods of low inflation. Cutting rates becomes difficult
when interest rates are already near
12

econ focus

• first / second quarter • 2024

zero, something known as the zero
lower bound problem. He cited several
studies that found 2 percent was, in
his words, “the lowest inflation rate
for which the risk of the funds rate
hitting the lower bound appears to
be ‘acceptably small.’” (Prior to the
public declaration of the inflation
target, the funds rate did hit the zero
bound during the financial crisis, and,
as discussed below, this further motivated Bernanke’s desire to make that
formal announcement.)
THE LONG ROAD TO THE
CONSENSUS STATEMENT
Bernanke would succeed Greenspan
as Fed chair in 2006. He clearly held
a different view than his predecessor with respect to the need for the
FOMC to be transparent in its approach
to inflation, but he could not act on
his own. In the March 2007 FOMC
meeting, Bernanke took the committee’s temperature on several questions
that needed to be addressed if it was
going to make any changes to existing policy, including whether there
should be a target or a range and any
time horizon that might be involved.
The exchange, however, revealed the
committee was still split along these
dimensions. For example, Jeffrey
Lacker, who had become Richmond Fed
president in 2004, favored a 1 percent
inflation target with a range of plus or
minus 1 percent and a clear time horizon of two years. Yellen, then president of the San Francisco Fed, favored
a 1.5 percent target with a range of 1
to 2 percent, but preferred it be a longrun goal and not bound by a fixed time
horizon. Still others, like Dallas Fed
President Richard Fisher, opposed a
target altogether, arguing that there
was no evidence countries with a target
performed better at managing inflation
than those without a target. (Earlier
studies comparing economic outcomes
between countries with inflation targets
— for example, New Zealand, Germany,
Canada, and the United Kingdom —
and those without did not show clear

evidence that such policies improved
economic outcomes. Later work would
show that inflation targeters better
managed price and inflation shocks as
well as economic uncertainty.)
Despite these differences, Bernanke
hoped they still might find a path
forward through the Summary of
Economic Projections, a quarterly
compilation of each Fed governor’s
and Reserve Bank president’s projections for a series of economic indicators
such as GDP, employment, and inflation. By adding another year to participants’ inflation forecasts, they might
all cluster around a single number,
which could serve as a substitute for an
announcement of numerical specification. “The hope was, everyone will have
the same forecast and then we can go
home,” says Lacker. “But we were all
over the map. So then they added the
column for the longer term after all the
shocks had died out. That failed, too.”
By 2009, the financial crisis had
worsened. Bernanke sensed inflation was falling too quickly, which can
lead to higher real interest rates. On
the other hand, the potential for rising
inflation prompted by the quantitative easing needed to fight the crisis
worried him as well. Still, action proved
elusive, as Congress voiced concerns
about the need to also focus on employment, and committee turnover brought
in new members who were skeptical of
a targeting framework.
The committee did not discuss an
inflation target between January 2009
and October 2010, when the concerns
over disinflation (that is, declining
inflation) evolved into worries about
deflation (negative inflation). Those
worries prompted Bernanke to revive
the idea of a target as a possible way to
enhance the forward guidance effects
of the 2010 round of quantitative
easing known as QE2, meaning that
the target would help communicate to
the public that the Fed was committed to an inflation rate higher than
it was at the time. (See “The Future
of Forward Guidance,” Econ Focus,
Fourth Quarter 2022.)

“The next time we do anything ...
I think we ought to have a framework that says, ‘Here’s our objective,’” he told the committee in August.
“And then we say that we’re trying to
achieve an inflation rate ... and that we
are going to calibrate our purchases
or sales in a way that tries to reach
that target.” But the committee was
still divided, and the announcement
of $600 billion in asset purchases after
the November 2010 meeting did not
include any language along those lines.
Undeterred, supporters on the FOMC
still believed it was possible to get
broad support for a framework. The
November 2011 meeting included an
expanded discussion devoted to monetary policy frameworks, and 11 of the
14 participants spoke in favor of adopting some form of a flexible inflation
target. Bernanke asked Yellen to head
an effort to create a statement of principles that would tackle several potentially controversial issues: identifying a
numerical inflation objective, outlining
how that number was consistent with
the dual mandate, explaining why there
would be no employment mandate, and
describing how the committee thought
about time horizons.
The final product of those efforts
— and all those before — was the
January 2012 Statement on LongerRun Goals and Monetary Policy
Strategy, which introduced the 2
percent inflation target to the public:
“The Committee judges that inflation at the rate of 2 percent, as
measured by the annual change in
the price index for personal consumption expenditures, is most consistent
over the longer run with the Federal
Reserve’s statutory mandate.”

To get to this point, however, the
committee also needed to address the
maximum employment mandate to
everyone’s satisfaction. In a 2020 article, Lacker recalled that the statement
had to “delicately finesse the divergent
philosophies of participants regarding the meaning of the term ‘maximum
employment’ and its role in monetary
policy.” To do so, the statement left
the term undefined but noted that it is
“largely determined by nonmonetary
factors that ... may change over time
and may not be directly measurable.
Consequently, it would not be appropriate to specify a fixed goal for employment.” Ultimately, this phrasing, and
the entire document, was acceptable
to almost all participants, as only Gov.
Daniel Tarullo abstained from supporting the document.
The committee opted for the specific
2 percent target, even though many
participants over the years had advocated for a range. Lacker has cited two
potential explanations for this shift.
First, advocates of a single numerical
target — often called a “point target”
— thought that a range might imply
the committee was satisfied with any
number within it, even if variations
within the range were economically
significant. Second, Lacker notes that
at that time during the financial crisis,
inflation was running below 2 percent.
That meant that “a range wasn’t as
dovish as a point target,” he suggests.
“If we say 2 percent, that will provide
more impetus for expansive policy.”
In August 2020, the FOMC released
an updated Statement on Longer-Run
Goals and Monetary Policy Strategy
that maintained the 2 percent target.
It made several changes, however. (See

“The Fed’s New Framework,” Econ
Focus, First Quarter 2021.) Most notably, it acknowledged that inflation since
2012 had frequently been below
2 percent, and so it stated that after
such periods, the committee would
allow inflation to rise “moderately above
2 percent for some time,” bringing the
long-term average back to target. It
also changed its approach to employment: Where the 2012 statement indicated that the committee would move
to reduce employment if it thought it
had surpassed what it viewed as “maximum” employment, the new statement
indicated that it would only want to
reduce employment if it was necessary
to keep inflation under control. Finally,
it expressed concern that with interest
rates near zero at the time, future policy
might be constrained by the zero lower
bound, increasing downward risks to
employment and inflation.
The committee will likely begin
another review of its longer-term goals
in the coming months. It is currently
operating under the 2020 framework but is not constrained by its new
features, however, as inflation in recent
years approached double digits: more
than “moderately” above 2 percent.
Instead, it has acted to bring inflation
back down to that 2 percent target.
Even during this period, long-run
inflation expectations have remained
anchored, rising no higher than 2.5
percent, according to the Cleveland
Fed. Those expectations have their
roots in the FOMC’s work as far back
as the 1990s, suggests Lacker. That
work, bolstered by the launch in 2012
of an explicit inflation target, “was
what helped over time cement expectations about inflation.” EF

READINGS
Bernanke, Ben. “Panel Discussion.” Speech at the 28th Annual
Policy Conference, “Inflation Targeting: Prospects and Problems,”
hosted by the Federal Reserve Bank of St. Louis, Oct. 17, 2003.
King, Robert G., and Yang K. Lu. “Credibility and Explicit Inflation
Targeting.” In Robert G. King and Alexander L. Wolman (eds.),
Essays in Honor of Marvin Goodfriend: Economist and Central
Banker. Federal Reserve Bank of Richmond, 2022.

Lacker, Jeffrey M. “A Look Back at the Consensus Statement.” Cato
Journal, Spring/Summer 2020, vol. 40, no. 2, pp. 285-319.
Shapiro, Adam, and Daniel J. Wilson. “The Evolution of the
FOMC’s Explicit Inflation Target.” Economic Letter 2019-12,
Federal Reserve Bank of San Francisco, April 15, 2019.

econ focus

• first / second quarter • 2024 13

B Y M AT T H E W
WELLS

The End of the Student Loan
Repayment Moratorium
Borrowers didn’t have to make payments for three and a half years.
How will they — and the economy — weather a rapidly changing
student loan landscape?

C

“

ollege is an investment.” It’s a common line
in dinner table conversations about higher
education. The conventional wisdom is that
college will set graduates on a trajectory
where they are likely to earn far more than
they would have otherwise. Indeed, research from the New
York Fed suggests that recent college graduates on average
earn substantially more — upward of $24,000 per year more
— than workers in the same age group with only a high
school degree. And this wage premium for college graduates
only increases over time, as it goes from about 27 percent
at age 25 to 60 percent by age 55, according to Harvard
University economist David Deming. Clearly, there are
substantial short- and long-term financial benefits to graduating from college.
At the same time, while the price tag on higher education
options can vary, the costs of attending college or graduate school have increased dramatically. As a result, student
loans currently are the third-largest source of household
debt, behind mortgages and car loans. Some 43.2 million
Americans hold a total of $1.6 trillion in student loans — a
figure nearly three times what it was around 15 years ago
— with an average monthly payment of between $200 and
$300. About 4.3 million of those borrowers live within the
Fifth District.
When economic activity ground to a halt with the onset
of the COVID-19 pandemic in March 2020, those monthly
payments became difficult for many borrowers to make.
To ease the strain, the CARES Act — a massive economic
stimulus package signed into law by President Trump that
same month — contained a moratorium on the repayment
of government-held student loans, as well as on interest
accrual. Payments were originally paused until September
of that year, but forbearance was extended repeatedly under
the Trump and Biden administrations. The moratorium was
finally lifted a little more than three years later, in June
2023, as part of the debt ceiling deal negotiated between the
Biden administration and the Republican majority in the
House of Representatives; payments and interest accrual
resumed later that fall.

14

econ focus

• first / second quarter • 2024

EFFECTS OF THE MORATORIUM
The New York Fed has reported that about $260 billion in
total loan payments were paused during the moratorium.
Instead of this money going back to the government, it
remained in borrowers’ pockets, altering their spending and
consumption habits.
In a May 2023 working paper, economists at the University
of Chicago characterized the moratorium as a large economic
stimulus where borrowers substituted “increased private
debt for paused public debt.” Specifically, they found that
rather than using the money to pay down other debt, eligible
borrowers (that is, those with government-held loans) spent
those funds on other things, expanding their balances on
credit cards, mortgages, and auto loans by an average of
3 percent, or about $1,200, compared to borrowers with
private loans that did not qualify for forbearance.
Who were the borrowers taking advantage of the moratorium? As it turns out, only 18 percent of federal loan borrowers continued to pay down their loan balances during that
period. All borrowers with government-held loans — regardless of loan amount, income, or family size — were granted
relief. But according to a 2023 report by economists at the
Federal Reserve Board and the Department of the Treasury,
families with children were most likely to benefit, as more
than half of families with eligible student loans had children.
Further, based on their income, families that were eligible
for relief were more well off than those that were not, “likely
at least partly driven by the fact that families with student
loan debt tend to have more education than those without.”
Perhaps most notably, the economists discovered blanket
forbearance was highly regressive, allowing higher-income
families to save more relative to lower-income borrowers,
as they tend to have higher monthly payments, “due partly
to having more debt and partly to reduced eligibility for
IDR [income-driven repayment] programs.” (IDR plans base
monthly payments on income and family size.)
These findings underscore the significant variation that
exists when it comes to how much individual borrowers owe and what educational programs they pursue with

Recent guidance from the Department of Education directs its loan servicers not to
report missed payments to credit bureaus.

Demonstrators in Brooklyn, N.Y., at an April 2021 rally for the cancellation of
student loan debt.

those loans. The median amount of a borrower’s outstanding student debt in 2022 was between $20,000 and $24,999
(that is, half of borrowers owed less, while half owed more)
— but the mean, or average, balance was just over $37,000 at
the end of 2023, according to the Department of Education.
This difference can be attributed in part to the fact that
borrowing is skewed by a minority of borrowers who take
on outsized loans: In 2021, 7 percent of borrowers owed over
$100,000 and 16 percent owed over $60,000. As the findings above suggest, borrowers with hefty loan balances are
likely those who pursue graduate or professional degrees
(for example, J.D.s, M.D.s, and MBAs), and those additional
degrees generally translate into higher incomes. For example,
the American Bar Association and Bureau of Labor Statistics
report the average education debt for a law school graduate is
$130,000 and the average salary is just over $148,000.

i m age : b e n vo n k l em pe r e r / s h u t t ersto c k

IS TROUBLE BREWING FOR BORROWERS?
Prior to the pandemic, the delinquency rate among student
loan borrowers (that is, those who missed at least one
payment) was about 23 percent, according to economists at
the New York Fed. One question coming out of the moratorium was what effect it would have on this number: Would
borrowers who benefited from three and a half years of
forbearance, and those who finished school during the
pandemic and moratorium, adjust to the new reality of
having to make potentially substantial monthly payments?
In August 2023, the New York Fed’s Household Spending
Survey asked borrowers this question.
Borrowers generally expected to make their payments at
the same rate as they did prior to the pandemic, but that
does not mean that all borrowers expressed the same level
of confidence. Indeed, the Household Spending Survey

showed significant variation across different demographic
groups. Female borrowers, for example, reported a
28.9 percent probability of missing a payment, more
than twice the 12.5 percent probability reported by men.
Borrowers with household incomes of less than $60,000 per
year reported an average probability of 39 percent of missing a payment, while those in households making above that
threshold had an average probability of only 14.3 percent.
Rajashri Chakrabarti is one of the New York Fed economists who conducted the survey. She notes that while
women are more likely than men to miss a student loan
payment, they also expect to miss non-student debt
payments at a lower rate. “That may be because women first
try to pay down the other kinds of debt and then student
debt, whereas the men do the opposite way,” she says.
Missing a payment in the current environment, however,
does not carry the same consequence that it might have
previously: Recent guidance from the Department of
Education directs its loan servicers not to report missed
payments to credit bureaus.
Further softening the blow for many borrowers, the
Department of Education unveiled the SAVE (Saving on
a Valuable Education) plan in the summer of 2023. Like
previous IDR plans, such as REPAYE, monthly payments
are based on the borrower’s income and family size. But
SAVE increases the income exemption from 150 percent
of the poverty line — the exemption under REPAYE — to
225 percent. This change means that a single borrower
who earns less than $32,805 a year, or $67,500 for a family
of four, will not have to make any monthly payments. The
Department of Education estimates that under SAVE, more
than 1 million additional low-income borrowers will qualify for a $0 payment, including 400,000 borrowers who were
previously enrolled in REPAYE and were automatically
transferred to SAVE.
As for the borrowers who make over 225 percent of the
poverty line, the Department of Education anticipates
that they will still save at least $1,000 per year compared
to what they paid under the REPAYE plan. Additionally,
if borrowers make a full scheduled payment each month,
they’ll avoid the situation of some borrowers in prior
programs whose loan balances actually grew over time as a
result of interest charges. In the SAVE plan, a loan balance
won’t grow because of unpaid interest from the previous
month. For example, if $50 in interest accrues each month
and you have a $30 monthly payment, the remaining $20
would not be charged if you make your monthly payment
on time. Data from the Household Spending Survey indicate
the SAVE plan has widespread popularity with borrowers,
as overall enrollment in an IDR plan went from 36.7 percent
before the moratorium to 57.9 percent of borrowers expressing interest in enrolling after the pause.
In terms of the effect of the moratorium’s end on the
wider economy, the Household Spending Survey found
that lifting the moratorium will likely have a small impact
econ focus

• first / second quarter • 2024 15

President Biden has used his executive authority to cancel student debt for smaller numbers of borrowers,
up to just under 4 million so far who have had about $143.6 billion in loans forgiven.
on consumption, perhaps about 0.1 percentage points
lower than aggregate levels as of August 2023, right before
payments restarted. This estimate is far less than initial
forecasts. When it became clear the moratorium would be
lifted in the spring and early summer of 2023, interest rates
had gotten relatively high and the economy had slowed,
leading observers to suggest the economy might experience
a 0.8 percentage point drop in consumption. These concerns
dissipated somewhat over time, however, as strong spending and growth continued, especially in the third quarter
of 2023, when GDP growth was 5.2 percent and spending
growth was 3.6 percent.
AFTER THE MORATORIUM: CANCELING DEBT
During the 2020 election, then-candidate Biden campaigned
on canceling $10,000 in student debt per borrower. Travis
Hornsby is a student loan consultant whose firm, Student
Loan Planner, helps borrowers navigate the world of student
loan repayment. He suggests that the combination of the
pandemic-induced moratorium and Biden’s victory led
many borrowers to believe their days of loan repayment had
ended, saying many were thinking, “Oh, wow! Biden won!
I’m never going to have to pay these loans again!”
President Biden attempted to follow through on that
campaign pledge in 2022, announcing his intention to
cancel $10,000 for borrowers making under $125,000 per
year ($250,000 for married couples), while Pell Grant recipients making under that same amount would have $20,000
in debt canceled. The plan would have wiped clean the
debt of about 20 million people — about half of all federal
loan borrowers — and the Congressional Budget Office estimated at the time it would have amounted to about $400
billion over the next 30 years that would not be going back
into government coffers. This is money the federal government would have to fund otherwise, most likely by borrowing, thereby increasing the level of debt for all Americans.
The U.S. Supreme Court, however, ruled in June 2023 that
the administration lacked the authority to grant such broad
relief, leaving borrowers to plan on resuming payments.
Unlike the blanket moratorium, the administration’s
cancellation plan would have granted forgiveness to those
borrowers earning under a specified income cap. Such an
idea may address one of the criticisms of universal loan
forgiveness — that it is too regressive, disproportionately benefiting the high-income earners who might not
need relief, and, at the same time, needlessly costing the
government billions in lost revenue. In studying the idea of
income-based eligibility, economists at the New York Fed
found means testing loan forgiveness reduces costs and
“drastically changes the distribution of benefits” by helping
those who have the hardest time making their payments.
Specifically, they showed that by forgiving $10,000 in loans
to borrowers earning under $75,000 — half of the income
in the Biden administration’s 2022 proposal — the overall
16

econ focus

• first / second quarter • 2024

cost of such a policy would drop by almost 45 percent.
But at the same time, the share of forgiven dollars going
to low-income neighborhoods would go from 25 percent
to 35 percent and the share going to those with delinquent loans would rise from 34 percent to 60 percent. (The
Department of Education argues that even under the plan
proposed in 2022, “90 percent of relief dollars [would] go
to those earning less than $75,000 a year.”)
Against the backdrop of the adverse ruling by the
Supreme Court, President Biden has used his executive authority to cancel student debt for smaller numbers
of borrowers, up to just under 4 million so far who have
had about $143.6 billion in loans forgiven. Some 513,000
borrowers with a total or permanent disability have had
their debt canceled, as have 1.3 million borrowers who
attended colleges or universities (many for-profit) deemed
to have defrauded them by misrepresenting their graduates’
employment prospects. An additional 793,000 borrowers
enrolled in the Public Service Loan Forgiveness program
also had their loans forgiven. This program grants forgiveness to borrowers working in the public sector and nonprofits after a decade, but the program suffered from poor
recordkeeping and loan servicing, as well as misinformation, which resulted in these borrowers not getting the
forgiveness to which they were entitled after making that
decade’s worth of payments. Bureaucratic failures also kept
930,500 borrowers who had been in IDR plans that predate
SAVE from receiving the relief they had earned after
making payments for over 20 years, which was the original expected duration. Most recently, in February 2024, the
administration announced that borrowers who originally
took out $12,000 or less in loans would have the balance
forgiven after as few as 10 years, impacting 153,000 borrowers holding a total of $1.2 billion.
If President Biden’s 2022 loan forgiveness plan had not
been struck down by the court, it would likely have carried
measurable economic consequences. Thomas Lubik and
Aubrey George of the Richmond Fed conducted what Lubik
calls a “thought experiment” in 2022 with a set of assumptions about the plan’s implementation that allowed them
to assess its potential effects. They found it was likely to
be inflationary, shifting the debt burden — somewhere
between $330 billion and $519 billion — from borrowers to
the government, adding roughly 1 percent to the existing
federal debt, which at the time was $30.6 trillion. This additional burden would have to be covered by future revenues,
namely higher taxation or a reduction in future spending;
unless those revenues were found elsewhere, the gap would
have to be covered by a reduction in the value of outstanding nominal debt. Lubik and George calculated this as a
one-time price jump that translated into a monthly inflation
spike as high as 1.7 percent.
Lubik says that with forgiveness now being granted
to smaller groups of borrowers and spread over time,
accounting for its inflationary effects is difficult to

For individuals who get relief, the benefits are obvious: They can focus on building a life
unburdened by potentially vast amounts of debt.
measure. “We imagined that student loan forgiveness is a
gigantic piece of additional government expenditure that
has to be financed because it shows up in the budget,” says
Lubik. “What we’re seeing now is that it’s slowly phased
in and the numbers are much smaller, and that would be
really hard to measure.”
IS LOAN FORGIVENESS THE FUTURE?
The administration has also announced additional initiatives
intended to ease borrowers’ debt burden. For example, for
most borrowers in the SAVE plan who make over 225 percent
of the poverty line, monthly payments on undergraduate
loans are currently set at 10 percent of their monthly income;
in July 2024, that will be reduced to 5 percent, essentially
cutting monthly payments in half. Also, the American Rescue
Plan Act, another COVID-19-era stimulus package passed
and signed into law in 2021, exempted student loan forgiveness from being counted as taxable income, including the
debt forgiven through IDRs like the SAVE plan. That provision is set to expire at the end of 2025, but President Biden’s
proposed 2025 budget would make it permanent, allowing any
future forgiveness to also be tax exempt.
Student loan forgiveness carries its share of controversy.
For individuals who get relief, the benefits are obvious: They
can focus on building a life unburdened by potentially vast
amounts of debt. While previous generations were able to
access middle-class American life by graduating from college
— thus justifying the debt incurred to do so — skyrocketing
tuition costs and no guarantee of a meaningful wage bump
(even for those with some graduate degrees) have created
burdens that prevent many of today’s graduates from doing
the same. Making monthly payments has simply made buying
a home, saving for retirement, or even putting money away
for their own children’s education too difficult. There is data
to back these claims, as research from economists at the New
York Fed, the University of California, Berkeley, Ohio State
University, and Cornerstone Research in 2021 suggests that
increasing tuition and student debt has contributed to declining homeownership rates among younger adults, as well as
weaker future spending and wealth accumulation.
At the same time, however, opponents maintain freeing

individuals from these debts raises issues of fairness.
Taxpayers who chose not to spend as much money on
their education — or pursue higher education at all — are,
in effect, required to subsidize those who did. Similarly, it
might be said to punish after the fact those who continued
to pay down their debt during the moratorium only to see
that it ultimately would have been forgiven.
Critics also note that continued forgiveness creates a series
of distortions that affect the incentives of actors and institutions in the future, and, if anything, it may make it even
harder to solve the broader problem of how to bring down
the costs of higher education. Forgiveness can lead to higher
loan amounts, as borrowers may believe that there is no
reason to not borrow the maximum amount if it will be
forgiven down the line. This, in turn, could translate into
higher tuition rates, as colleges and universities are said to
lack any incentive to keep costs down if they continue to
receive government money — although research by Grey
Gordon of the Richmond Fed and Aaron Hedlund of Purdue
University casts doubt on whether this hypothesis is correct.
Targeted programs like the Public Service Loan
Forgiveness program seem to have more broad support,
although they, too, raise questions about fairness and what
degrees and jobs society values. To complicate it further,
careers in medicine, business, or law carry high earning
potential and are respected by much of society, but workers
in those fields carry the bulk of the country’s student debt.
If policymakers provide relief to any group, should it be
to those professionals or to others who provide a valuable
service but struggle to make ends meet? And if policymakers elect to pursue blanket forgiveness of student loans, why
not forgive other forms of debt as well?
As the economy regains its footing and continues to grow,
the question remains whether new borrowers will also
benefit from future loan forgiveness initiatives and all the
consequences — both positive and negative — that result.
“From an economic point of view, investment in human
capital is beneficial because it increases future productive potential,” says Lubik. “Based on that, you can make
the argument that you want to subsidize higher education,
whatever the form. The question is whether student loans
are the best way to do this.” EF

READINGS
Bleemer, Zachary, Meta Brown, Donghoon Lee, Katherine Strair,
and Wilbert van der Klaauw. “Echoes of Rising Tuition in Students’
Borrowing, Educational Attainment, and Homeownership in PostRecession America.” Journal of Urban Economics, March 2021,
vol. 122, Paper No. 103298.
Chakrabarti, Rajashri, Daniel Mangrum, Sasha Thomas, and
Wilbert van der Klaauw. “Borrower Expectations for the Return
of Student Loan Repayment.” Liberty Street Economics, Federal
Reserve Bank of New York, Oct. 18, 2023.

Dinerstein, Michael, Constantine Yannelis, and Ching-Tse Chen.
“Debt Moratoria: Evidence from Student Loan Forbearance.”
National Bureau of Economic Research Working Paper No. 31247,
May 2023.
Goodman, Sarena, Simona Hannon, Adam Isen, and Alvaro
Mezza. “Implications of Student Loan COVID-19 Pandemic Relief
Measures for Families with Children.” Finance and Economics
Discussion Series No. 2023-025, Federal Reserve Board, May 2023.

econ focus

• first / second quarter • 2024 17

ECONOMIC HISTORY
by tim sablik

Tipping: From Scourge of Democracy
to American Ritual
Over the course of the 20th century, tipping went from rare and reviled to an
almost uniquely American custom. We still like to complain about it.

I

18

econ focus

• first / second quarter • 2024

A 19th century illustration of a restaurant in Chicago. Tipping was rare in the United States during
the first half of the century but became more common after the Civil War.

the height of the pandemic, prompting
them to be more generous. This experience, coupled with the inflation of
the post-pandemic recovery period, has
given businesses more incentives to ask
for tips.
“We’re in an environment where
there’s pretty much full employment,”
says Lynn. “Businesses are competing
for workers, and to do that, they need
to pay well. The problem is that it’s also
an inflationary environment, and businesses don’t want to further inflate their
prices to increase pay. Tipping is a natural solution to that problem.”
Even before this recent episode, the
rest of the world has tended to view
Americans as somewhat tip obsessed.

One travel guide by Australian airline
Qantas advises travelers to the United
States that “in America, tipping is
optional in name only.” In many countries in Europe and Asia, tipping is
either not the norm or the size of tips is
much smaller. But it wasn’t always this
way. In America’s early years, tipping
was rare and faced intense opposition from many who called the practice
un-American.
OVERSEAS ORIGIN
Historians aren’t entirely sure when
tipping began, but it may go as far back
as the ancient Roman Empire. In his
1998 book Tipping: An American Social

i m age : ge tt y i m ages

f you feel like you’re being asked to
tip in more places lately, you aren’t
alone. According to a Pew Research
Center survey released in November
2023, 72 percent of Americans agreed
that tipping is now expected in more
places than it was five years ago.
Social media is filled with stories
of customers being asked to tip for
all sorts of transactions where that
custom previously wasn’t the norm:
buying office furniture, going through
the drive-thru, or even paying for
lunch at a self-checkout.
A few factors seem to be driving this
trend. A growing number of businesses
have adopted more sophisticated pointof-sale payment terminals and software
developed by companies such as Square
and ShopKeep. Square reports that it
processed 4 billion transactions in 2022.
In addition to allowing small businesses
to easily accept non-cash payments,
these point-of-sale devices give owners
the option to include a tipping prompt
as part of the checkout process.
There is also some evidence that
customers increased tipping during the
pandemic. Michael Lynn, a professor
of consumer behavior and marketing at
the Cornell University School of Hotel
Administration who has published more
than 80 articles on tipping, found that
tipping frequency declined at restaurants in 2021 and 2022, but the size of
tips went up. In another study of data
from Square, Lynn found that the size of
tips also went up for quick-service and
takeout restaurants in 2020 and 2021.
Lynn and others have hypothesized
that many Americans felt increased
compassion for service workers during

History of Gratuities, historian Kerry
Segrave placed its origin in the Middle
Ages. In 16th century England, wealthy
travelers who came to stay in a friend’s
home would give money to the host’s
servants. These sums of money, known
as vails, were intended to compensate
the servants for taking on the additional work of caring for the guests on
top of their regular duties.
The custom grew quickly. Household
servants came to expect and even
demand vails, to the growing irritation of travelers. Segrave noted that by
the 18th century, even British royalty
complained about the rising cost of staying with friends because of the vails.
House staff reportedly went so far
as to threaten guests who refused to
pay. Ungenerous guests might be met
with spilled food at the dinner table or
an injured horse in the stables. Some
nobles reduced their travels to avoid
the issue altogether, while others tried
to band together to abolish the practice. Such efforts met fierce resistance.
A meeting in London in 1764 to discuss
the banning of vails was disrupted by
servants throwing rocks through the
windows of the meeting hall.
Around the same time, tipping also
started to emerge in English coffeehouses. Patrons would tip waitstaff
to receive better service. This may
be where the word “tip” entered the
English language, although there is
disagreement about its etymology. One
popular story is that the word came
from a particular London coffeehouse
frequented by English writer Samuel
Johnson in the mid-1700s. Reportedly,
tables in the coffeehouse had bowls with
the words “To Insure Promptitude”
printed on them, and patrons would
drop coins in the bowls to receive better
service. Tip is the abbreviation of this
phrase. However, Segrave provided
evidence that the word was already in
use prior to the time of Johnson, calling
this origin story into question.
In his book, he suggested that tip
may have come from the Dutch word
“tippen,” which means “to tap.” In this
context, it referred to the sound of a

patron tapping a coin against a glass to
get the server’s attention. Segrave also
observed that the words for tip in many
other languages are related to drinking.
“Pourboire” in French, which means
“for drink”; “trinkgeld” in German,
meaning “drink money”; and “propina”
in Spanish, which refers to an invitation
to drink. In English, the word “tipple”
means “to drink alcohol,” so tip may
be an abbreviation that emerged from
giving gratuities to bartenders.
Whatever the origins of the word,
by the late 18th century, it had become
increasingly customary in England
and other parts of Europe to give tips
to servants in domestic and commercial settings. In the early history of
the United States, however, tipping
remained uncommon and was subject to
intense criticism. The practice of giving
vails in England was wrapped up in
long-standing European class distinctions between the tipper (wealthy aristocrats) and the recipients (servants).
Many Americans viewed this practice
as antithetical to the country’s founding
egalitarian principles. A good example
of this sentiment can be found in The
Itching Palm, an anti-tipping book written by author and social activist William
R. Scott in 1916.
“In an aristocracy a waiter may
accept a tip and be servile without
violating the ideals of the system. In
the American democracy to be servile
is incompatible with citizenship,” wrote
Scott. “Every tip given in the United
States is a blow at our experiment in
democracy.”
Another reason why tipping may
have been slow to take off in America
is that, early on, the country lacked
many of the commercial establishments
where tipping was becoming common
in Europe. Stand-alone restaurants were
virtually unheard of in America before
the Civil War. As Marc Mentzer, professor of human resources and organizational behavior at the University of
Saskatchewan, documented in a 2013
article in the International Journal of
Management, early American hotels
were generally small and more akin

to a modern bed and breakfast. They
were typically run by a single proprietor with meals included in the price of
lodging. Guests would eat together with
the proprietor, family style. Mentzer
writes that meals at inns and taverns
were meant to invoke family meals at
home with the proprietor as head of
the household, and tipping would be
unthinkable in that context. By the 20th
century, however, this would all change.
TIPPING GAINS A TOEHOLD
Just as historians don’t entirely agree
when and where in the world tipping
started, there is also disagreement
about why Americans started to warm
to the practice.
“I don’t know that you can just point
to one or two things,” says Lynn of
Cornell University. “Everything that
I’ve read suggests that tipping really
took off in this country after the Civil
War. Americans traveling to Europe
picked up the custom there and
brought it back home with them.”
Ironically, tipping began to subside
in Europe as it took off in America.
Segrave noted that by the early 20th
century, Europeans complained that
American tourists had spoiled the
custom by habitually overtipping, priming tip recipients to also expect more
from locals. Others have suggested
that the end of slavery was an important factor. Freed slaves working service
jobs were often paid low wages, making
them reliant on tips. For example, the
Pullman Company hired Black workers as rail car porters almost exclusively
and paid them only $27.50 a month in
1915 (equivalent to about $835 in today’s
dollars). Investigations into the company
concluded that its workers could not
live on their salary without tips and,
knowing this, passengers felt even more
compelled to tip porters.
Tipping also began to spread to the
hospitality and food service industries
as those underwent changes after the
Civil War. As cities grew, so did hotels.
In his 2013 article, Mentzer documented how the small family meals
econ focus

• first / second quarter • 2024 19

E C ONOMIC HIS TORY

Between 1909 and 1915, six states
(Arkansas, Iowa, Mississippi, South
Carolina, Tennessee, and Washington)
took things even further, passing laws
criminalizing the solicitation and
giving of tips. Violators were subject
to fines and, in the case of South
Carolina, even jail time. But the laws
proved ineffective and were largely
ignored; by the 1920s, they had all been
repealed (or, in the case of Iowa, overturned by the state Supreme Court).

When Do Americans Tip?
Percentage of U.S. adults who say they always/often leave a tip when...
Eating at a restaurant with servers
Getting a haircut
Having food delivered
Buying a drink at a bar
Using a taxi or rideshare service
Buying a beverage at a coffee shop

STAYING POWER

Eating at a restaurant without servers
0

10
Always

20

30

40

50

60

70

80

90 100

Often

SOURCE: Pew Research Center, "Tipping Culture in America: Public Sees a Changed Landscape," Nov. 9, 2023.

presided over by the hotel proprietor
gave way to larger dining rooms with
waitstaff to accommodate the increased
number of guests. Meals were still
served family style and included in the
price of a room (a practice known as
the American plan, compared to the
European plan where the cost of meals
was separate from lodging). Waitstaff
would distribute food to guests from
serving trays, and some guests would
occasionally try to tip for a better cut
of meat or more food. Hotel managers
largely discouraged this practice, viewing it as attempted bribery.
According to Mentzer, the start of
Prohibition in 1920 changed things.
Prior to that, hotels relied heavily on
alcohol sales to subsidize food services
and even lodging. This left hotel
owners with several problems to solve.
First, they needed to find a use for
hotel bars. Second, they needed to find
ways to reduce costs across the board
to make up for lost alcohol sales.
“The idea of allowing patrons to
leave some extra money for servers
became very attractive to hotel owners
because it reduced pressure on them
to increase wages,” says Mentzer. “So,
hotel owners started to see tipping as a
desirable thing.”
20

econ focus

• first / second quarter • 2024

Hotels also started switching
from the American meal plan to the
European plan to further manage
costs. Bars were converted into standalone lunch counters where food was
purchased a la carte. Mentzer argues
that tipping came to be viewed as
more acceptable in this context, since
customers were no longer trying to
bribe servers to get more of a shared
plate; rather, they were offering something extra as thanks for their individual meal and service.
Still, tipping continued to face fierce
opposition as it spread in America.
Unions in the early 20th century
frequently opposed the practice because
they felt it stood in the way of workers
being paid fair wages and left them too
dependent on the whims of customers. Business owners, particularly hotel
managers, also feared that the proliferation of tipping requests would annoy
and drive away guests. Some hotels
installed something called a Servidor
in guestroom doors. It was a compartment that could be opened from both
sides, allowing hotel staff to leave
cleaned laundry that the guest could
then retrieve inside the room without
meeting the employee face-to-face and
being asked for a tip.

Despite ongoing opposition, tipping
endured and expanded as a feature
of American life. In restaurants, a
10 percent tip was customary in the
first half of the 20th century. By the
1980s, that baseline had risen to 15
percent, and today 20 percent has
become increasingly common. This
steady rise may make it seem like there
are well-established rules governing
tipping, but in the 2023 Pew survey,
only about a third of respondents said
they thought it was very easy to know
when and how much to tip in all situations. (See chart.) What can explain
the endurance of a custom that many
people find so confusing even after
more than a century of practice?
From an economist’s perspective,
tipping could be an efficient system
for monitoring the behavior of service
employees. If customers give better tips
for better service, this should naturally
reward the best employees, making the
manager’s job easier. On the surface,
this would seem to be the main reason
for the persistence of tipping. When
asked, nearly 80 percent of Americans
say that the quality of service is the
most important factor in determining
whether and how much to tip. But in
practice, service quality has little bearing on tipping generosity.
In a 2009 Applied Economics article,
Ofer Azar of Ben-Gurion University
of the Negev reviewed several studies
that examined the effect of customer
service quality ratings on the size of
tips. Those studies found that better

service quality did increase tips but
only by a little — not enough to be a
meaningful incentive for workers. The
disconnect between service quality and
tip size is also evident in the fact that a
tip is usually a percentage of the total
bill, making tips larger at more expensive restaurants even though menu
prices have little to do with service
quality.
“One possibility is that tipping
improves social welfare even without improving service quality if most
customers feel better with tipping than
without it,” says Azar.
In a series of research articles, Azar
developed a model in which customers derive utility from complying with
the social norm of tipping and feeling
generous by tipping above the minimum expected amount. As long as
the utility customers gain from these
feelings exceeds the monetary cost of
leaving a tip, the custom will persist.
The model can also explain why the
expected percentage size for tips has
risen over time. If customers regularly tip above the minimum amount
because it makes them feel good, then
social norms will adjust to reflect this
new higher minimum. Customers
will then have to tip even more to feel
generous, pushing up the average tip
size again.
Customers also seem to prefer tipping
because of how they perceive prices,
which has made it hard for restaurant owners to do away with the practice. At first glance, it would seem that
business owners benefit from tipping.
Federal law allows employers to pay
tipped workers as low as $2.13 an hour
as long as their wages plus tips equal
or exceed the federal minimum wage
of $7.25 an hour. But Lynn says that it
isn’t so easy for owners to capture these

savings because the restaurant industry
is so competitive. Most restaurants pass
these savings on to customers in the
form of lower prices.
Efforts to replace tipping with higher
menu prices or a fixed service fee
have been met with resistance, even
if the final cost to customers is the
same. In 2015, national chain Joe’s
Crab Shack removed tipping at 18 out
of 131 restaurants. At those locations,
menu prices were raised to pay servers
higher wages. In a 2018 article, Lynn
examined the results of this experiment and found that online consumer
reviews were more positive for the
restaurants that retained tipping than
they were for the ones with no tipping.
“It turns out that if customers are
comparing a restaurant with higher
prices and no tipping to a restaurant
with lower prices but where you are
expected to tip, they think the restaurant without tipping is more expensive,” says Lynn. “They focus on menu
prices when determining how expensive a restaurant is.”
Restaurateurs have continued to
experiment with service charges in lieu
of tips to equalize pay between tipped
and non-tipped staff, with mixed
results. The HOUSEpitality Family
restaurant group, which owns nine
restaurants in Richmond, announced
in February that it would remove the
automatic 20 percent service fee that
it had been applying to its bills. The
owners began the practice during the
COVID-19 pandemic to provide more
income stability for workers, but it
proved to be a flop with both customers and staff, who preferred tipping.
This lines up with the results of the
2023 Pew survey in which 72 percent
of respondents said they opposed automatic service charges.

TIPPING POINT?
Will the proliferation of tipping
requests change public sentiment
enough to overturn the custom? As
surveys and history make plain, most
people are not in favor of the alternatives, no matter how much they may
scratch their heads about when and
how much to tip.
“It’s so deeply entrenched that it’s
hard to squelch,” says Mentzer. In
his 2013 article, he concluded that “if
tipping could survive being treated as
a criminal act, perhaps it can survive
anything.”
Rather than banning tips as in
the past, a handful of states have
attempted to make workers less reliant on them by raising the minimum
wage for tipped workers to match that
of non-tipped employees. Voters in
Washington, D.C., approved a measure
in 2022 to equalize the minimum wage
for tipped and non-tipped workers by
2027. Recent legislation in Maryland
would have done the same thing, but
the bill was tabled after facing opposition from restaurant workers and
owners. Many were concerned that the
change would reduce customer tips
and ultimately result in tipped workers
earning less. There is some evidence
that average tip percentages are lower
in states with higher minimum wages
for tipped employees, but it is unclear
whether those workers earn less
overall.
“I have a hard time imagining any
scenario in which tipping goes away,”
says Lynn.
At the end of the day, who benefits
the most from the tipping system?
“People who don’t tip very well,” says
Lynn. “They’re being subsidized by the
people who do.” EF

READINGS
Azar, Ofer H. “The Economics of Tipping.” Journal of Economic
Perspectives, Spring 2020, vol. 34, no. 2, pp. 215-236.
Lynn, Michael. “Service Gratuities and Tipping: A Motivational
Framework.” Journal of Economic Psychology, February 2015,
vol. 46, pp. 74-88.

Mentzer, Marc. “The Payment of Gratuities by Customers in the
United States: An Historical Analysis.” International Journal of
Management, September 2013, vol. 30, no. 3, pp. 108-120.
Segrave, Kerry. Tipping: An American Social History of Gratuities.
Jefferson, N.C.: McFarland & Company Inc., 1998.
econ focus

• first / second quarter • 2024 21

INTERVIEW

Ulrike Malmendier
On law versus economics, the long-term
effects of inflation, and the remembrance of
crises past

O

22

econ focus

• first / second quarter • 2024

EF: How did you become interested in economics?
Malmendier: There were a couple of motivations that played
a role. One is that my father had experienced the after-effects
of World War II in Germany, so he had a strong notion that
you better go for a job where you could earn a safe living.
I did pretty well in high school, yet my dad insisted that
it would be better to first go to a bank and do one of these
German-type apprenticeships. It was practical. I know how
to evaluate you for a loan, open your account, and so on.
And you study a little bit; I did a two-year degree in business economics. So I’m a publicly certified banker. It was very
much a result of this scarring from the past, the idea that we
never know what’s going to happen.
When I actually started studying, I went to the University
of Bonn. I was interested in both economics and law. I
was initially more leaning toward law, specifically ancient
Roman law; in fact, I ended up doing a whole Ph.D. in law.
But since my bank experience, I had economics always in
the back of my mind. In the Juridicum building in Bonn,
where the law students are taught, the economics students
are also taught. So I managed to also get into the economics program. Formally, it was actually not possible to enroll
in both degree programs, but when somebody dropped out, I
applied for their slot and got it.
What I experienced in the program was theory, mechanism design, the beauty of math, which kind of led me
back into economics. The very mathematical, not very realworld-oriented way in which we were taught economics in
Bonn just intellectually attracted me. I had some excellent
teachers there. That’s really the way I found my path into
economics.

i m age : co u rt e sy n oa h b e rger

ver the course of her career, much of the
research of University of California, Berkeley
economist Ulrike Malmendier has been in the
areas of behavioral economics and behavioral corporate
finance — looking at the effects of various psychological biases, such as overconfidence, on the decisions of
consumers, investors, and executives.
Malmendier’s more recent work has taken a turn that
has made her the Marcel Proust of economics — focusing, like the French novelist, on the subjective nature
of human experience and its enduring influence. In this
research, she has been analyzing “experience effects”:
how individuals living through financial crises and other
significant economic events respond to these experiences
in their future financial behavior. In her view, a major difference between homo economicus (the hypothetical person of classical economics who is perfectly rational and
perfectly informed) and actual people is that, as she puts
it, “The homo economicus is more of a robot who processes
data rather than a living organism whose mind and body
absorb these experiences.”
In addition to faculty appointments at Berkeley’s economics department and Haas School of Business, she
is faculty director of Berkeley’s new O’Donnell Center
for Behavioral Economics, which she co-founded with
her husband and Berkeley economics colleague Stefano
DellaVigna.
A native of Germany, where she studied ancient Roman
law before moving to economics, Malmendier has seen her
research published in, among other journals, the American
Economic Review, the Quarterly Journal of Economics, and
the Journal of Finance. She has received numerous awards,
including, in 2013, the American Finance Association’s
prestigious Fischer Black Prize, awarded biennially to
a leading finance scholar under the age of 40 for significant contributions to the field. She is also a fellow of the
Econometric Society and the American Academy of Arts
and Sciences. The German federal government appointed
her in 2022 to the five-member German Council of
Economic Experts, sometimes called the Five Sages.
David A. Price interviewed Malmendier by phone in
January.

EF: That sounds like a big switch
from law.
Malmendier: In the civil law systems
like you have in Germany, and which
go back to Roman law, it’s not math,
but it’s pretty close. You really have
to learn the whole big model and how
to filter through the case at hand and
come to the answer. It’s quite stimulating intellectually in a way that
seems very related to math. At 8 p.m.
on Thursdays, we would meet in the
Roman Law Institute, sit between the
old books and then open up the Corpus
Iuris Civilis, the big work of Roman
law, and take a piece of the Latin text,
translate it, and discuss the logic and
how it flows. That was an exercise with
an almost mathematical feel to it.
EF: Turning to your research, one
of the things you’ve found is that
people’s likelihood of buying a home
rather than renting is influenced
by their experiences with inflation.
Please explain.
Malmendier: I’ll step back for the
bigger picture here. In general, I have
been very interested in the question
of how our personal lifetime experiences tend to change us, tend to change
the outlook we have of the world, the
way we form beliefs. They might also
influence our preferences, although my
work is a bit more on the beliefs side.
I mentioned how my early life path
was influenced by my dad experiencing World War II and how everything
can get destroyed — the house gets
destroyed, you lose all your possessions
and savings, and maybe your country’s currency isn’t worth anything
anymore. One way of looking at the
effects of this is simply in terms of
information: After such an experience, you have new data about what
can happen. That’s the traditional
economic view. But I’d argue that
there’s an element beyond the intellectual. When it’s your own life, you
tend to put a lot of weight on what has
happened to you. You’re pushed toward

overweighing outcomes that have
happened to you.
I first worked on that in the context
of the stock market, with a paper
Stefan Nagel and I wrote on Depression
babies in the U.S. We showed that
people who experience big crashes
of the stock market tend to shy away
for years and decades from investing
anything in the stock markets. We then
turned to another experience, inflation.
Here, the example of Germany was
our motivation. Within the EU, the
Germans are somewhat notorious
for being preoccupied with inflation
being a terrible thing and distrusting
the European Central Bank to handle
it well. That’s our reputation. But
where does it come from? Many people
think that it might have something to
do with Germany going through the
hyperinflation in the Weimar times and
that experience affecting the German
populace strongly — so strongly that
the adverse reaction was even transmitted to the next generations.
With that big motivation in mind,
we thought experience effects might
also apply to inflation. Suppose I’ve
lived through a period of high inflation,
such as the Great Inflation in the U.S.
of the late 1970s, early ’80s. Even if I
am an economist and work on monetary policy and inflation, I’m still going
to be affected by that personal experience. If I’m asked to forecast inflation
on the margin, I may overweigh what
I saw happening; I may overweigh the
probability that prices can spiral out of
control.
If that’s the case, it’s going to influence my financial decision-making. I
would want to protect myself against
inflation. So how can I protect myself?
I put my money into protected assets.
In addition to gold and the stock
market and so on, one way is to invest
in real estate. And so one prediction
is that people who are worried about
their money being worth much less in
the future might want, on the margin,
to buy a home rather than rent.
Also, if I can finance this home
purchase with a fixed-rate mortgage,

so I’m borrowing at a fixed rate — but
I think inflation will go up — I believe
that it’s going to be a good deal. I don’t
really like variable-rate mortgages at
all in this case because I’m worried
about the risk of nominal rates adjusting upward. So that’s the link between
inflation experience and making financial decisions that protect yourself
against inflation.
EF: Many people are familiar with
the idea that Depression-era youth
were affected by that experience
throughout their lives. How do you
think the experiences of the past
several years will tend to affect
young Americans of today?
Malmendier: For starters, look at
inflation, which started creeping up
since 2021, and then in 2022 you were
getting close to the double digits. There
was such a sharp contrast between the
long period of the Great Moderation
and all of a sudden that price shock
kicking in. For older people, who have
seen high inflation before in the ’80s
or even the ’70s, I’m predicting they’re
just taking that into the average of the
long period of low inflation since the
early 1980s and of their experience of
high inflation in the 1970s and early
1980s. Given their long history of experiences, the new spike does not get too
much weight. It just goes up a bit.
But for young people in the United
States who basically had seen no inflation at all outside of textbooks, it’s a
different story. All of their life before
they had experienced very low inflation, and then all of a sudden there’s
the spike. Initially, then, they might be
a little slow to react. But if the spike
in inflation lasts long enough — it isn’t
just a two-month blip — they realize,
whoa, the world I live in is different
than the world I thought I was living
in, where high inflation happens only
in textbooks.
So the weight they put on that
experience increases and can in fact
end up being much higher than for
older generations because the new
econ focus

• first / second quarter • 2024 23

INT E RVIE W
experience makes up a much larger
part of their lives after it has happened
for two years or so. Applied to the
current situation, we are now moving
slowly and steadily toward the 2
percent inflation target, and we might
avoid the complete scarring effects.
One area where I do expect big experience effects from recent years is
living through the COVID-19 crisis and
many of us being relegated to working from home. I do expect there to be
a lasting change in how we view the
value of social interaction, the value of
working from home versus working at
your workplace.
The leadership here at the Haas
School of Business, where I am right
now, is encountering exactly this issue.
They wonder why the same people
who were happily coming in five days
a week before COVID absolutely refuse
to do so now. It’s clearly an experience
that has changed people. In the classical economic model, you would just
talk about the information obtained
from that experience and maybe the
setup cost of learning Zoom. But that
can’t explain everything. We knew the
length of our commutes before COVID.
And yet, personally experiencing
what remote work and cutting out your
commute means for your personal life
makes an enormous difference. You
have to experience it first, not because
of lack of information, not because you
cannot add and subtract hours spent in
the car versus not, but because it just
enters your decision-making differently
if you have physically experienced it.
EF: If I’m, let’s say, on the Federal
Open Market Committee, am I also
subject to these forces of experience?
Malmendier: Yes, you are. And that
is maybe the most surprising aspect
to many economists. Allow me to step
back again: When behavioral economics and behavioral finance started
playing more of a role in our profession, the applications initially focused
on individual investors or individual
consumers — the man or woman on the
24

econ focus

• first / second quarter • 2024

Ulrike Malmendier
■ present positions

Cora Jane Flood Professor of Finance, Haas
School of Business, University of California,
Berkeley; Professor of Economics, University
of California, Berkeley; Faculty Director,
O’Donnell Center for Behavioral Economics,
University of California, Berkeley
■ selected additional affiliations

Research Affiliate, Centre for Economic Policy
Research; Faculty Research Fellow, Institute
for the Study of Labor (IZA); Research
Associate, National Bureau of Economic
Research
■ education

Ph.D. (2002), Harvard University; Ph.D.
(2000), University of Bonn; B.A. (1996),
University of Bonn; B.A. (1995), University
of Bonn
street, so to speak. We would have not
thought that these biased beliefs play
a role for the highly informed, highly
trained, highly intelligent, successful
leader of a company, a Federal Reserve
Bank president, a Federal Reserve
Board governor.
Even before I was working on the
research on experience effects, I was
wondering about that. Because biases
reflect something our brain is wired
to do, it doesn’t need to be negatively
correlated with intelligence. So my
earliest work in behavioral finance in
fact was about overconfident CEOs.
And I vividly remember when presenting this paper on the job market two
decades ago how certain audiences
would tell me, look, I know several
CEOs, they’re very smart, how can
you argue they are biased? But it turns
out biases do apply, even to the most
successful CEOs.
Going back to experience effects,
our work here is based on basic neuroscience underpinnings: Namely, that
as we are walking through life and
making experiences, neurons fire and
so cause connections between neurons,
synapses, to form. When experiences
are repeated and last longer, then these

connections become stronger. So, if I’ve
gone through a period of high inflation and seeing a price increase triggers fear and worry, well, that’s also
happening to highly informed and
well-trained and knowledgeable policymakers, even at the very highest level.
That’s why their past personal experiences can help us to predict who is
leaning more on the hawkish or the
dovish side. We have actually found
strong evidence of it.
And I’ve asked the same question about bankers. I’ve looked at the
reports of banks’ financial situations
— provided thanks to the Fed — on
how close they might have been to a
bank run, how close they have been
to financial distress, and whether that
affects their lending behavior in later
years. For instance, if a bank experienced the Russian debt default crisis in
1998, their situation during this crisis
has a lasting influence on their future
choice of exposure in these kind of
debt markets.
EF: It seems like you’re quite interested in the psychological level of
explanation for economic behavior.
What drew you to studying these
kinds of issues?
Malmendier: Partly it goes back to
those times at the University of Bonn,
where I was initially sitting in my law
lectures, and then I was venturing
over to the very mathematical theoretical economics lectures. As beautiful
as the modeling and analysis of equilibria was, I was struck by the sharp
contrast between the human behavior we analyzed in my law classes and
how human behavior was modeled in
my economics lectures. In law, humans
make mistakes and emotions play a
role. For example, for how the penal
code considers somebody’s attempts
to kill somebody, it matters whether
that person was being driven by the
moment or cold-bloodedly planned
the murder. It makes a difference in
how law assesses and penalizes this
behavior. In economics, there was no

consideration of motives or emotions.
And then, when I started studying at Harvard for my second Ph.D.,
the economics Ph.D., I was lucky that
there was rising interest in behavioral
economics. It was still a time when it
was not broadly accepted, when advisers told me that I might not want to
go on the job market with behavioral economics research, but it was
slowly changing. For me, behavioral
economics really clicked. It injected
the psychological realism we need to
make good predictions and have good
suggestions for policy.
Now I’m trying to go beyond that.
We see in classical economics the homo
economicus who is perfectly optimizing
— taking all the information and coming
to the perfect decision. Behavioral
economics came around and said, well,
that’s unrealistic. Let’s inject some
psychological realism. Let’s introduce
overconfidence, self-control problems,
etc. And that was all good.
But here is the thing that was still
missing: If you think about the homo
economicus as a computer with a
program that perfectly solves the problem at hand, behavioral economics
was still kind of dealing with humans
like computers. They now had flawed
software or maybe occasionally short
circuited. But however you program
them initially — with overconfidence
and so on — they are running that
program for the rest of their lives.
This newer agenda on experience
effects emphasizes much more that, no,
humans are not just software, flawed
or not flawed. They are living, breathing organisms. As they walk through
life, they adapt and change their
outlook on the world. That means that
we as economists have a lot to learn,
not just from social psychology, which
was great for behavioral finance, but
also from other fields — from neuroscience, from psychiatry, from endocrinology, etc. People who have lived
through a monetary or financial crisis
come out of that scarring experience
with their brains rewired, and they
will make different decisions.

They will keep overweighing this
outcome happening again. But I think
there’s much more to learn. For example, the neuropsychiatrists tell us if you
do live through a crisis but you feel like
“you can do something about your situation” — what they call controllability
— then you tend to do better. You don’t
tend to be so affected, so traumatized
by it.
So I’m personally of the opinion
that there’s robust evidence in medicine, biology, neuropsychiatry, cognitive science, which we haven’t incorporated as much as we should. I’m
a bit on a mission to get economists
more broadly, not just behavioral
economists, to open up to that — of
course, acknowledging that behavioral
economics, the first round, got us a big
step forward.
EF: Are there strategies that people
can use to overcome the effects of
their negative experiences and make
better decisions?
Malmendier: Yes, absolutely.
For contrast, let me start, though,
from the strategy that a lot of policymakers and economists believe in but
that works much less well than we
used to think. That strategy is teaching
people. That’s the strategy I naturally
like as a professor. I used to think that
if only I teach people about the equity
premium puzzle and about diversification, then they will understand they
need to put their money in a broadly
diversified low-fee fund rather than
having it in some savings account, or
worse, checking account, etc., and they
would all be better off.
Hence the emphasis on financial
literacy. But so far, the process has
been muted. Now, I still think financial literacy training is useful; it’s
important. But it tends to be less effective than we professors often hope
compared to the effect of personal
experiences with the stock market or
other financial instruments.
Theoretical knowledge is just less
powerful than we used to think. People

might not act on information, and it is
not because of asymmetric information, frictions, and access to information. All of that exists and is relevant.
But even if you have full access to the
relevant information, if you’ve understood it, if you’ve processed it, you
might still not act on it unless you’ve
seen it work in practice.
That brings me to the more direct
answer to your question. If you feel
that due to past info exposure, you are
acting in a somewhat biased way, and
you want to remedy it, the best recommendation is to slowly expose yourself to doing the alternative action or
environment and personally experience
the resulting outcome and in that way
rewiring your brain.
From neuroscience, we don’t just
learn that life experiences rewire our
brain and infer that, after a high-inflation period, we might be scared and get
triggered when we see price increases.
We also learn that throughout our
lives, our brain has a high plasticity —
maybe less than when we’re young, but
throughout our lives, we are pruning
synapses that we don’t need anymore,
we are strengthening others, so we can
affect how we think about the world. If
we manage to expose ourselves to the
right setting, that helps us not only to
intellectually understand, but almost
physically understand, why a certain
type of decision is the right one. We
change our wiring.
If somebody is really scared about
the stock market, doesn’t want to
go there, the literature on experience-based learning would suggest
something like a cognitive behavioral
therapy approach. Namely, let’s just
take $50 or $100 and put it in a broadly
diversified low-fee fund. In the worst
case, that’s not too much loss. After
a year, we look back and see what
happened to it and realize, huh, that
wasn’t so scary. That worked out pretty
well even at a bad time. That way,
we are rewiring our brain and maybe
coming around to the conclusion that,
to accumulate wealth, we should be
doing more of that.
econ focus

• first / second quarter • 2024 25

INT E RVIE W
EF: In recent research, you’ve found
that the experience of leading a
company during the Great Recession
tended to make CEOs age faster.
What’s going on there?
Malmendier: It’s very connected to
this high-level view I have of the evolution of what economics is about and
should be about. The mind and the
body are altered in many ways as we
are walking through life. In the work
on experience effects, I’ve mostly
looked at how our beliefs are altered
and how financial decisions or inflation expectations are then affected. But
I mean it quite literally when I say we
need to look at mind and body. Leading
your company through that stressful
period of the Great Recession probably
makes you a different person beyond
just having more information.
Working with people from our
computer science department, I was
exposed to machine learning and
convolutional neural networks and
learned about this subfield that looks
at face recognition and visual machine
learning. I thought we could apply
it to detect signs of stress and aging.
That led us to collect pictures of CEOs
before and after crises and to show
that we actually age in a crisis. In a
severe enough crisis — if I take the
usual corporate finance definition, the
median firm in your industry undergoing a 30 percent or higher stock price
decline — it makes you look an additional one year older.
And this visual effect really does
seem to translate into effects on your
health. While I couldn’t get measurements of cortisol levels or heart rates

or the like, I was able to get data on
longevity. And what we saw is that if
you look one year older, you are actually
aging faster in the sense that you unfortunately die one year earlier. So it translated pretty much 1-to-1 into longevity.
What I’m hoping is that with this
paper, we can further strengthen the
point that we need to think about
humans with all their biology. We have
a lot to learn that’s relevant for predicting career paths, education, all the
usual outcome variables we economists
are interested in.
EF: What are you working on now?
Malmendier: The physical realm of
what crises do to you is something that
is staying with me. I have been interested in digging deeper. What is the
most stressful aspect of it all? What
are the actual stressors? In a related
project on CEOs, we ask what kinds of
specific situations or decisions trigger
these adverse effects in your body and
on your health. For CEOs, it turns out
to be layoff decisions. It’s really hard
on a leader to have to let a large fraction of their employees go, particularly
if they’ve been with the company for a
long time.
Also, going back to the inflation
topic: The recent bout of inflation,
not just here in the U.S., but also in
Europe, has gotten me interested in
how the lower-income parts of the
population are affected by inflation.
When studying inflation and inflation expectations, economists tend
to look at the professional forecasters and market participants who have
an impact on markets outcomes. The

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econ focus

• first / second quarter • 2024

low-income populations are less studied. But they are, of course, the people
for whom the marginal price increase
in groceries has the highest marginal
utility impact.
I’m trying to estimate to what
extent inflation affects their consumption behavior. As goods become more
expensive, what can they still afford?
And what do they want to afford? That
is, is the effect of inflation on their
spending coming fully, or almost fully,
through the channel of constraints,
or do beliefs play a role? Also, is there
a nonstandard element in their belief
formation? There’s a lot of research
on hand-to-mouth consumers, about
adjustment frictions of consumption
that could play a role. But present-biased preferences could also play a role;
limited attention could play a role.
We got access to a fairly new dataset on low-income consumers and are
exploiting the recent bout of inflation as a source of variation. We ran
a survey on that sample to tease out
what factors play a role. So far, we are
finding that, first of all, it’s not just
all constraints; beliefs do matter. And
they are correlated with difficulties in
managing debt. People who have difficulties managing their debt are reacting to inflation in an unexpected way,
moving further toward overconsuming relative to what the data say they
should be doing. This suggests there
might be some nonstandard factor at
play that got them into difficulties in
managing debt to begin with.
That’s what the preliminary results
suggest. I hope to learn more about
this population and the impact of inflation on them. EF

DISTRICT DIGEST
b y c a r r i e c o o k , s t e p h a n i e n o r r i s , a lva r o s á n c h e z , a n d a d a m s c av e t t e

Understanding SNAP’s Role

T

he Supplemental Nutrition
Assistance Program (SNAP) is
a key component of the United
States’ social safety net and supports
millions of Americans annually by
providing food vouchers for households
with low income and assets. SNAP
supports households enduring persistent
poverty as well as those temporarily
in economic distress, as its enrollment
expands during recessions to accommodate the unemployed. Economists
Robert Moffitt of Johns Hopkins
University and James Ziliak of the
University of Kentucky have explained
that SNAP operates like an automatic
stabilizer — that is, a counterweight to
the boom-and-bust economic cycle —
by subsidizing low-income Americans
with almost universal eligibility during
economic downturns.
This article explores how SNAP
enrollment varies over time and across
Fifth District states. The report also
investigates the program’s effects on the
outcomes of benefit recipients and its
function as a key resource within lowand moderate-income communities.
Community organizations play a role in
facilitating access to SNAP and supplementing its benefits via food banks,
local kitchens, and farmers markets.
BACKGROUND ON SNAP
SNAP is the predominant source of
nutrition assistance among the many
anti-hunger programs for low-income
households in the United States, such
as the Special Supplemental Nutrition
Program for Women, Infants, and
Children (WIC) and the National
School Lunch Program (NSLP). In
April 2023, 41.9 million people in 22.2
million households received SNAP
benefits, representing 12.5 percent of
the national population.
SNAP’s origins can be traced to the
Food Stamp Program of 1939, where

participants could prepurchase all food
and receive subsidies for any food that
the U.S. Department of Agriculture
(USDA) classified as surplus. The
program was phased out by 1943 but
reemerged in the form of pilot programs
in select sites in the early 1960s. Core to
his War on Poverty, President Lyndon
Johnson made the program permanent by signing the Food Stamp Act of
1964. The Agriculture and Consumer
Protection Act of 1973 (the “farm bill”)
initiated the program’s expansion to
all U.S. counties beginning in 1974.
The Food and Nutrition Act of 2008
renamed the program SNAP, reiterating
the program’s expressed goal of alleviating hunger and malnutrition by increasing the purchasing power of low-income
households.
SNAP is federally funded through
the USDA Food and Nutrition Service
and administered in partnership with
state social service agencies. Program
eligibility is determined at the household level through a set of basic enrollment requirements for participants.
Generally, SNAP participants must
meet work requirements to receive
benefits. Participants are required to
register for work, take a job if one is
offered, participate in employment and
training programs if they are assigned
by their state, and not voluntarily quit a
job or reduce hours. The gross monthly
income of participants must be at
or below 130 percent of the federal
poverty line for a given household size,
and their net income must be no more
than the poverty line. The total assets
of participants are subject to certain
limits: Households with at least one
member who is 60 or older or disabled
cannot have assets over $4,250, while
households without such members
have assets capped at $2,750.
Benefits are disbursed to SNAP
participants monthly and accessed with
an Electronic Benefit Transfer (EBT)

card that can be used at retail stores.
The EBT card, which is like a debit
card, can be used only for food. The
value of the monthly benefit provided
to participants is calculated using the
household’s net income and a predetermined maximum benefit amount
that is based on the current value of
the Thrifty Food Plan (TFP). The TFP
is USDA’s estimate of a healthy diet
at its lowest cost, adjusted for various
household sizes for the determination
of benefit values. Participants who earn
no income receive the maximum benefit amount based on the TFP, while
participants who earn income receive a
benefit amount equal to the maximum
benefit for their household size minus
30 percent of their net income.
During the COVID-19 pandemic,
SNAP benefits were expanded to
provide households with a larger “emergency allotment” of benefits. As of
March 2023, however, SNAP emergency allotments were discontinued,
and benefit amounts returned to their
normal levels. The scale of the increase
and subsequent decrease was significant: The average SNAP benefit in April
2023 was $181.72 per person and $343
per household, compared to $245.44 per
person and $464.36 per household in
February 2023 prior to the discontinuation of emergency allotments.
PARTICIPATION DIFFERENCES OVER
TIME AND GEOGRAPHY
In line with the idea that SNAP acts as
an automatic stabilizer, SNAP participation tends to be countercyclical —
in challenging economic times, SNAP
caseloads rise, and then they drop as
the economy improves. This is largely
driven by an increase in the number
of households that are eligible due to a
drop in labor income. Peter Ganong of
the University of Chicago and Jeffrey
Liebman of Harvard University found
econ focus

• first / second quarter • 2024 27

DIS T R IC T DIG E S T

Average Annual Change in Persons Receiving SNAP Benefits by State
30
25
20
15
10
5
0
-5
-10
-15

2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
North Carolina
West Virginia

Maryland
Virginia

South Carolina
District of Columbia

SOURCE: Small Area Income and Poverty Estimates via FRED
NOTE: Gray bar indicates the Great Recession.

that, on average, a one percentage-point
increase in unemployment increases
local SNAP enrollment by 15 percent.
This pattern has been evident in the
Fifth District as the number of people
receiving SNAP benefits increased
during the Great Recession but started
trending downward in 2013. (See
chart.) The number of SNAP recipients
increased in early 2020 as job losses
and relaxed program requirements
increased the number of eligible households and reduced barriers to participation. In 2022, roughly 41.2 million
individuals in 21.6 million households
received SNAP benefits, up from 35.7
million individuals in 18 million households in 2019.
While all households and individuals
are subject to federal SNAP eligibility
requirements, states have some discretion over who qualifies to receive benefits. For example, federal law disqualifies anyone from receiving SNAP if
they received a state or federal felony
drug conviction involving the possession, use, or distribution of a controlled
substance after 1996. State legislatures,
however, have the latitude to opt out or
impose less severe restrictions on SNAP
eligibility. In the Fifth District, Virginia
and the District of Columbia have opted
28

econ focus

• first / second quarter • 2024

out of the ban entirely while Maryland,
West Virginia, and North Carolina
have instituted modified restrictions on
SNAP benefit eligibility for individuals with felony drug convictions. South
Carolina is the only state in the country not to opt out of the lifetime ban on
SNAP following a conviction.
Not all SNAP-eligible households
receive monthly benefits. In 2019, the
share of individuals eligible for benefits
who are not actively enrolled — sometimes called the “SNAP gap” — was
around 19 percent. Among the working
poor — households that are below the
poverty threshold despite having at least
one household member in the workforce
for at least half the year — the uptake
rate was 71 percent. Older adults (age 60
or older) have significantly lower rates
of uptake than eligible adults overall; in
2019, only 48 percent of eligible seniors
received SNAP benefits.
Variation in SNAP uptake rates
across states reflects differences
in state policies and demographic
characteristics of eligible households. In a handful of states, including Massachusetts, Oregon, and
Pennsylvania, the share of those eligible who are not enrolled is effectively zero — all eligible individuals

received SNAP benefits in 2019. Some
other states, like Wyoming, Arkansas,
and Kentucky, had an uptake rate of
less than 70 percent, meaning that
more than 30 percent of those eligible for benefits did not receive them.
In the Fifth District, SNAP uptake
rates ranged from 74 percent in South
Carolina to 97 percent in the District of
Columbia. (See chart on next page.)
What might keep eligible households from participating in SNAP?
Insufficient access to program information and eligibility guidelines is one
barrier: Some households might not
know that they qualify for benefits or
how to apply if they do qualify. Stigma
may also prevent some households
from taking advantage of the program.
Program requirements — administrative or financial hurdles that households must overcome — are another
challenge that may discourage some
eligible households. Recipients who
struggle to meet work requirements
and recertification deadlines may find
it difficult to stay enrolled.
Household income is an important factor in whether households seek
benefits. The lowest-income households (who would be eligible for the
highest amount of monthly benefits) tend to have among the highest uptake rates — about 99 percent
in 2019. Among eligible households
with income over 130 percent of the
federal poverty line, the uptake rate
was only 21 percent in 2019. Ganong
and Liebman found that many state
and federal policy changes in the
2000s increased program enrollment,
including simplified reporting, extending certification periods, and allowing phone calls in place of face-to-face
interview requirements.
FIGHTING FOOD INSECURITY
AND POVERTY
The USDA defines food insecurity —
inclusive of low and very low food security — as the “limited or uncertain availability of nutritionally adequate and
safe foods, or the limited or uncertain

Share of Eligible Population Participating in SNAP by State
As noted earlier, the temporary emergency allotments between 2020 and 2023
increased monthly SNAP benefits. An
analysis of the emergency allotments by
the Urban Institute estimated that in the
fourth quarter of 2021, nearly 4.2 million
people were lifted out of poverty, reducing the SPM by 9.6 percent in states that
still provided emergency allotments relative to a scenario where the policy was
eliminated.

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

District of
Columbia
Participating

Maryland

North
Carolina

South
Carolina

Virginia

West
Virginia

Not participating (SNAP gap)

SOURCE: USDA FNS, Reaching Those in Need: Estimates of State SNAP Participation Rates in 2019 (Technical Report)
			

ability to acquire acceptable foods in
socially acceptable ways.” Overall, food
insecurity affected an estimated 10.2
percent of U.S. households (13.5 million
households) at some point in 2021,
with about 56 percent of food-insecure
households reporting participation in
at least one of the three federal nutrition assistance programs (SNAP, WIC,
NSLP). Research has also shown disparate impacts of food insecurity for select
groups, such as households with children, communities of color, and adults
who are not working.
Unsurprisingly, food insecurity
engenders reduced spending on food
at home and lower dietary quality,
especially for low-income households.
Moreover, across a wide range of literature, food insecurity has been associated with adverse health consequences
on affected households. Food insecurity has been linked to chronic conditions such as asthma, cognitive and
behavioral disorders, hypertension, and
diabetes, among a host of other health
outcomes. For working adults, the risk
of chronic illness has been shown to
increase as the severity of food insecurity increases.
SNAP fills a critical gap in the provision of nutritious and affordable food
to households experiencing food

insecurity. The primary mechanism by
which SNAP can alleviate food insecurity is through the supplementation of
participant income, enabling households
to increase the amount of food they
can purchase monthly. One large study
conducted by the USDA found that
participating in SNAP over a six-month
period was associated with about a 5
to 10 percentage point decrease in the
share of households experiencing food
insecurity. An additional study found
that receiving SNAP reduces the likelihood of becoming food insecure by
around 30 percent and decreases the
likelihood of experiencing very low food
security by 20 percent.
SNAP reduces the prevalence of
poverty for participating households.
The Census Bureau estimates that
between 2016 and 2018, SNAP reduced
the percentage of individuals living
beneath the Supplemental Poverty
Measure (SPM) threshold by just over
1 percentage point overall and by 2
percentage points for children under
age 18 (or 3.5 million fewer people
in poverty overall). Another estimate
found that SNAP reduces poverty by
14 percent to 16 percent, depending on
the poverty measure under consideration and after adjusting for underreporting of benefit receipt.

THE ROLES OF COMMUNITY
ORGANIZATIONS
Community-based organizations
seek to inform low-income individuals and families about SNAP benefits and help them apply. For example,
Affordable Homes and Communities
(AHC), a nonprofit developer of affordable housing based in Arlington, Va.,
reports that all of its resident services
team members are trained to assist
residents as needed with applications
for programs like SNAP, WIC, and
Medicaid. In addition to one-on-one
support assisting residents, AHC partners with organizations like Real Food
for Kids that promote SNAP education,
and DHS to host community resource
fairs and additional food distribution efforts. Michele Walker, executive
director of County United Way, which
serves areas of Maryland and West
Virginia, states, “We all work collectively to ensure we are maximizing
participation in SNAP.”
Organizations across the region
report that SNAP benefits have not
kept pace with the increasing costs and
actual needs for food, especially after
the discontinuation of pandemic-era
emergency allotments. Some organizations report this discrepancy as particularly noticeable for single individuals, households with multiple children,
and older adults. Their monthly allotments are frequently cited as insufficient to meet the actual costs of a nutritious and balanced diet. DC Hunger
Solutions Director LaMonika Jones
reports that many older adults in the
District of Columbia saw their monthly
econ focus

• first / second quarter • 2024 29

DIS T R IC T DIG E S T

benefits reduced from $281 to the local
minimum of $30. Perhaps as a result,
community-based organizations have
advised Richmond Fed staff of a significant uptick in households requesting
financial and other assistance — some up
more than 200 percent year over year.
Some organizations and policymakers are finding ways to increase
program utilization and supplement
SNAP benefits. The South Carolina
Office of Social Services offers the
“Healthy Bucks” program which
allows SNAP recipients to obtain
additional fresh fruits and vegetables
when they use their SNAP benefits
to purchase fresh produce at participating Healthy Bucks Vendors. These
vendors are typically farm stands,
farmers markets, and food share
programs. Farmers markets across
the region also report accepting SNAP
benefits, and food banks are increasingly hosting “pop up” food distributions to reach families in need.
WHEN WORKERS LOSE ELIGIBILITY
Even as organizations encourage
the use of SNAP and other benefit
programs, households are experiencing benefits cliffs challenges. Benefits
cliffs occur when marginal increases
in earnings disqualify low-wage workers from public assistance programs,
hampering their financial independence and career advancement.
Several organizations report that
clients have opted to work part time
only, even though they could work
full time, because their part-time
income and SNAP benefits resulted in
a higher total monthly income than if
they were to work full time and lose
benefits.
For example, County United Way’s
Michele Walker notes that a new
employee breached the SNAP benefits
cliffs upon starting her new role and
now faces challenges feeding herself
and her young daughter. Even though
she has a full-time job with benefits,
the worker struggles to make ends
meet amid increasing living costs and
30

econ focus

• first / second quarter • 2024

“feels penalized for trying to better
herself in the workforce.” Walker
noted that a gradual reduction in
benefits in response to the worker’s
earnings, rather than a cutoff, would
help with an adjustment period and
not losing benefits so dramatically as
people are working toward economic
mobility.
SNAP AND LONG-TERM OUTCOMES
OF RECIPIENTS
The longer-term effects of SNAP
on the well-being of recipients have
been extensively studied by social
scientists. Research has indicated
that SNAP benefits may improve
health outcomes for SNAP recipients.
Christian Gregory of the USDA and
Partha Deb of Hunter College studied
data from the Medical Expenditure
Panel Survey and found that SNAP
participants (compared to those eligible but not participating) have better
self-reported health, three fewer sick
days per year, and one or two fewer
doctor visits per year compared to
nonparticipants. Additionally, research
suggests that SNAP improves health
outcomes for recipients’ children over
time. Douglas Almond of Columbia
University, Hilary Hoynes of the
University of California, Berkeley,
and Diane Whitmore Schanzenbach
of Northwestern University found
that enrolling pregnant women in the
food stamp program three months
before birth resulted in higher birth
weights. Studying the effect of SNAP
receipt on children’s health outcomes
using restricted access data from the
National Health Interview Survey,
Chloe East of the University of
Colorado, Denver finds that the loss of
parental eligibility before age 5 negatively affects their child’s health in
the medium run at ages 6-16. Almond,
Hoynes, and Schanzenbach investigated the effect of childhood access
to benefits on adult health outcomes
during the Food Stamp Program’s
introduction in the 1960s using data
from the Panel Study of Income

Dynamics. The authors concluded that
“access to food stamps in utero and
in early childhood leads to significant
reductions in metabolic syndrome
conditions (obesity, high blood pressure, heart disease, diabetes) in adulthood.” Therefore, access to SNAP not
only improves the health of the adult
recipients themselves, it also improves
the health outcomes of their children
from birth through adulthood.
Researchers have found that
improved nutrition and health through
SNAP benefits affects children along
other important dimensions as they
reach adulthood. The authors above
found that in addition to reducing metabolic syndrome conditions in adulthood,
young children’s exposure to SNAP
also yielded improvements in economic
self-sufficiency for women. Similarly,
Marianne Bitler of the University of
California, Davis and Theodore Figinski
of the U.S. Department of the Treasury
used a similar research design and
found that women who lived in an
area where food stamps were available during early childhood had higher
earnings in adulthood. A recent study
by Martha Bailey of the University
of California, Los Angeles, Hilary
Hoynes, Maya Rossin-Slater of Stanford
University, and Reed Walker of the
University of California, Berkeley on
the long-term effects of early childhood
access to the Food Stamps Program
found that the program was associated with increases in measures of
adult human capital, economic self-sufficiency, and neighborhood quality, as
well as reduction in the likelihood of
incarceration.
CONCLUSION
Uptake in SNAP, a long-standing
poverty-reduction program, varies over
time and geography depending on the
U.S. business cycle as well as state-specific factors. Community development
organizations play a role in aiding
access to the program and supplementing benefits when they are insufficient
for household needs. EF

Community Conversations are opportunities for Richmond Fed leaders to visit
a wide variety of communities across our district to learn about their overall
economic well-being, their challenges, their concerns, and their successes.
During these visits, Richmond Fed President Tom Barkin meets with business and
community leaders to exchange economic updates and ideas.
Recent visits included:
• Learning about balancing rural and urban dynamics in southeastern Virginia peanut country
• Hearing about efforts to transform the economy away from coal and toward tourism and
recreation in southern West Virginia
• Discovering how natural resources can draw new residents and increase tourism in rural
western Virginia
• Discussing strategies for building and retaining a skilled workforce in South Carolina

To learn more, visit our website: https://www.richmondfed.org/region_communities/community_development/conversations

econ focus

• first / second quarter • 2024 31

OPINION
by thomas lubik

When Economists Navigate by the Stars

M

onetary policy is often likened to steering a ship.
The median neutral policy rate projected by FOMC members
For instance, the key economic policy concept of
in the latest Summary of Economic Projections sits at 2.5
“commitment” is often visualized as Odysseus
percent, while the prominent Laubach-Williams estimate of
listening to the Sirens’ call while tied to the mast of his
the New York Fed has it at 3.1 percent. The Richmond Fed’s
ship; analysis and interpretation of the data often seems like
model even comes in at 4.2 percent! So, what is a good Viking
the process of navigation by the currents, the wind, and the
to do when confronted with such uncertainty?
sky. Indeed, Fed Chair Jerome Powell suggested in August
Some commentators have suggested that r* is not a useful
that monetary policymakers are frequently “navigating by
concept for guiding monetary policy precisely because of
the stars under cloudy skies.”
this wide range of uncertainty. For instance, one might
But what good is celestial navigaargue that estimating r* and the uncertion if the navigator cannot see the
tainty surrounding this estimate is
sun or the stars because of clouds? The
like — to switch metaphors — ordering
The Vikings, apocryphally, used
Vikings, apocryphally, used sunstones,
pizza delivery for 8:30 p.m. on a Friday
sunstones, a mineral that polarizes
a mineral that polarizes light and
night that is promised to arrive somelight and allows determination of
allows determination of the sun’s locatime between 6 and 11 p.m.
the sun’s location with reasonable
tion with reasonable precision. Modern
Now, most of the time the pizza
economists likewise use alternative
does, in fact, get delivered at 8:30
precision. Modern economists
methods to steer the policy ship to its
p.m. Very rarely, the driver shows up
likewise use alternative methods
desired long-run resting place. They
at 6 because it’s a slow evening and
to steer the policy ship to its
employ statistical techniques to extract
he or she wants to close shop early.
desired long-run resting place.
the presumed location of the stars from
Sometimes, the delivery is quite late
what they see in the data.
because it is a busy Friday night. As an
They employ statistical techniques
At the Richmond Fed, we produce
economist analyzing the data, I know
to extract the presumed location
one measure of such a star, called r*
of these possibilities because they
of the stars from what they see in
(pronounced “r-star”), or in the econhave occurred in the past. Naturally,
the data.
omist’s vernacular, the natural real
my range of estimates would reflect
rate of interest. r* is an old theoretical
this even though I consider 8:30 as the
concept originated by the Swedish econmost likely outcome.
omist Knut Wicksell more than 100 years ago. It describes
The upshot of this metaphor is that as a policy advisor, I
the (hypothetical) real interest rate toward which an econneed to make our president aware of the range in delivery
omy would gravitate and at which it would be in balance,
times and counsel him not to take the dog for a walk during
with neither inflationary nor deflationary pressures.
this time frame. He may if he must and if he is willing to
r* has received much recent attention in the monetary policy
take the risk that the pizza gets cold on the doorsteps. But
debate as the Federal Open Market Committee (FOMC) is
he should certainly be at home around 8:30.
contemplating the path for interest rates in 2024. r* can serve
Taking into account this uncertainty of the state of the
as a guidepost for their eventual direction. For instance,
world is the hallmark of good policymaking. For one, it
when the policy rate is above this neutral rate, monetary
avoids the illusion of false precision of fundamentally
policy is restrictive in that it tends to constrain economic
uncertain matters. Moreover, r* and other stars are just one
activity. This, in turn, tends to reduce inflation so that over
of many inputs into the policymaking process. Just as the
time, policy rates normalize. In such an equilibrium, the
Vikings eventually ended up at their destination, so will
policy rate moves toward its normal level, which can be
monetary policy. But without guidance from the stars, the
ascertained by adding the FOMC’s 2 percent inflation target
Vikings would have never reached land. EF
to r*.
But just like the ancient Vikings, who sometimes would
Thomas Lubik is a senior advisor in the Research
land in Northumbria, at other times in Wessex or even
Department of the Richmond Fed. He leads the team that
Iceland, economists arrive at different neutral policy rates.
produces the Richmond Fed’s quarterly estimate of r*.

32

econ focus

• first / second quarter • 2024

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of Richmond
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Richmond, VA 23261
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