Full text of FedViews : November 9, 2018

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Twelfth Federal Reserve District

FedViews
November 9, 2018

Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
https://www.frbsf.org/economic-research/publications/fedviews/

Adam Shapiro, research advisor at the Federal Reserve Bank of San Francisco, stated his views on the current
economy and the outlook as of November 9, 2018.

•

The economy has continued to grow at a solid pace. After a strong second quarter, real GDP grew at
an annual rate of 3.5% in the third quarter according to the advance estimate of the Bureau of
Economic Analysis. We forecast that GDP will grow at an annual rate of 2.4% in the fourth quarter
and average 3.1% for 2018. As monetary policy continues to normalize, we expect growth to
gradually fall back to our long-trend estimate of 1.7%.

•

Reflecting a very strong labor market, the economy added 250,000 jobs in October. Monthly job
gains have averaged over 200,000 for the past six months, well above the amount needed to absorb
the flow of new workers into the labor force.

•

The unemployment rate stands at 3.7% as of October. We expect it to decline to 3.4% by the end of
next year as the economy continues to grow. Over the longer run, we expect the unemployment rate
to gradually return back to its natural rate of 4.6% as monetary policy accommodation is removed.

•

The yield curve continues to flatten as short-term rates rise while longer-term rates have remained
more steady. At the November meeting, the Federal Open Market Committee (FOMC) announced its
decision to keep the target range for the federal funds rate unchanged at 2 to 2.25% and is proceeding
with the balance sheet normalization process initiated last year.

•

Inflation reached the FOMC’s target of 2% this past summer. The personal consumption expenditure
(PCE) price index and the core PCE index both rose 2% over the last 12 months. As the labor market
continues to tighten, we expect inflation to slightly overshoot the 2% target by 2019.

•

Inflation can be driven by either aggregate or industry-specific factors. Price sensitivity varies by
sector. Prices in some sectors are more sensitive to overall economic conditions, while prices in other
sectors are more sensitive to industry-specific factors. For example, shelter prices tend to move with
overall economic conditions, whereas prices for health care services tend to follow public payment
growth rates set by the Centers for Medicare and Medicaid Services (CMS).

•

The recent rise in inflation to the 2% target was attributable to the sectors that tend to be more
sensitive to industry-specific factors, that is, acyclical factors. Acyclical inflation is now contributing
0.5 of a percentage point more to overall core inflation than it was a year ago. The inflation rate for
prices that tend to be sensitive to the state of the economy, that is, cyclical inflation, has remained
fairly steady over the past year, despite an improvement in economic conditions.

•

Acyclical inflation is quite volatile, meaning it tends to move above and below its average level quite
rapidly. The contribution of acyclical inflation to core PCE inflation is currently relatively high,

The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco.
They are not intended to represent the views of others within the Bank or within the Federal Reserve System. FedViews generally
appears around the middle of the month. The next FedViews is scheduled to be released on or before December 21, 2018.

implying some downside risk to the inflation outlook should this series revert back to its average
level over the past 17 years.
•

Cyclical inflation, by construction, tends to move with overall economic conditions. The contribution
of cyclical inflation to core PCE inflation is now lower than what would be expected given the
current level of the unemployment gap. This implies some upside risk to the inflation outlook should
cyclical inflation revert to levels historically observed in very tight labor market conditions.

•

Overall, a decomposition between acyclical and cyclical factors shows balanced risks to the inflation
outlook. The median 10-year ahead personal consumption expenditure inflation forecast in the
Survey of Professional Forecasters has remained at 2%, showing that market participants view the
risks to the inflation outlook as balanced around the FOMC’s target.