BOSTON (MNI) – The following is the third and final section of text
of the remarks of Boston Federal Reserve Bank President Eric Rosengren
prepared Wednesday for the Massachusetts Chapter of NAIOP, the
Commercial Real Estate Development Association:

Figure 12 shows the U.S. share of world oil consumption (in blue)
ticking down, but also clearly shows (in red) the steady climb in the
share consumed by three of the so-called emergingmarket economies –
China, India, and Brazil. Figure 13 shows the growth in oil consumption
in those three countries, in the upper three lines. Both charts depict
quite strikingly the heightened demand for oil emanating from emerging
markets.

Returning to the U.S. and inflation concerns, Figure 14 shows that
the growth rate of employee compensation has generally been declining
over the past two decades. With compensation slowing and productivity
increasing, many firms have been profitable and able to withstand
increases in commodity prices without passing such costs on to final
prices. This fits with the observation that higher food and energy
prices have not tended to have much of an impact on prices in situations
where food and energy are not direct costs of doing business. Figure 15
shows two measures of inflation expectations, plotted alongside oil
price movements. The red line shows what professional forecasters
expected inflation to average over the next 10 years, at various points
in time. Their expectations have declined somewhat over the past 20
years, but what is striking is the relative stability of their inflation
expectations. In addition, there was no significant reaction to the oil
price shock that we experienced in 2008. The chart also shows a second
measure of inflation expectations – the University of Michigan Survey
(the green line), which asks respondents about their expectations for
inflation over the next 5 to 10 years6. Again these expectations are not
very responsive to movements in oil prices, and have remained quite
stable over the past two decades.

It is worth noting that countries can be affected quite differently
by supply shocks. As Figure 16 shows, the importance of food in the
“basket” of goods purchased by consumers can vary greatly by country. In
less developed countries, food is a very significant component of
overall purchases by consumers. In a developed country such as the
United States, food is a much smaller share of overall purchases. Thus
the impact of a food-supply shock on the overall inflation rate and on
other important economic variables such as wages and total imports can
vary widely by country. Given the different impacts of supply shocks, it
is not surprising that monetary policy is likely to react differently to
a supply shock such as food, depending on the unique characteristics of
the particular country.

Figure 17 shows that in the United States, the importance of food
as a component of inflation measures has been declining over time. And,
despite improvements in energy conservation that have lowered the per
capita consumption of oil, higher energy prices have contributed to
recent increases in the importance of energy in the consumer price
index. The fact that food and energy prices have been quite volatile
recently, but remain a relatively small part of the entire basket of
goods, helps to explain why core inflation rates have not been
particularly responsive to food and energy shocks.

Concluding Observations

In conclusion, I recognize that recent supply shocks have caused
pressures on many household budgets, and have led some analysts and
observers to become concerned about potential long-term inflationary
impacts. However, I think the evidence shows that over the past 25 years
most supply shocks have been transitory – and have had no long-lasting
imprint on longer term inflation, or on inflation expectations.

Nonetheless, recent historical trends do not always continue, so it
is important to monitor inflation dynamics very closely to make sure
that this pattern is continuing in the incoming data. In particular, I
will look intently at whether there is any evidence that the
expectations of underlying inflation have changed. To date, expectations
seem quite stable and show no evidence of diverging from the recent
past. I am committed to responding decisively, and as forcefully as
necessary, to ensure that long-term inflation expectations remain stable
and that food and energy price increases are not passing through to
other prices.7

Given the important role of labor costs in a developed,
services-focused economy such as the United States, it is important to
closely monitor trends in labor markets. Currently, wages and salaries
are reflecting heightened unemployment, and show no evidence that
potential inflation concerns are placing upward pressure on wages and
salaries.

Core inflation rates tend to be a reasonable predictor of inflation
in the intermediate term. Core inflation remains well below my long-run
target for inflation. This gives us flexibility to focus on
accommodative monetary policy doing what it can to promote more rapid
growth in the economy. As Figure 18 illustrates, the percent of the
adult population that is employed now is quite low in relation to recent
history, and has shown only a slight improvement over the course of the
recovery.

So with significant slack in labor markets, stable inflation
expectations, and core inflation well below our longer run target, there
is currently no reason to slow the economy down with tighter monetary
policy. Until we make more progress on both elements of the Federal
Reserve’s mandate – employment and inflation – the current,
accommodative stance of monetary policy is appropriate. Thank you.

NOTES:

1 My colleague Geoffrey Tootell, Director of Research at the Boston
Fed, has prepared an illuminating public policy brief that investigates
whether commodity price spikes cause long-term inflation. The brief,
which will be available at
http://www.bostonfed.org/economic/ppb/2011/ppb111.htm, examines the
relationship between trend inflation and commodity price increases and
finds that evidence from recent decades supports the notion that
commodity price changes do not affect the long-run inflation rate.
Evidence from earlier decades suggests that effects on inflation
expectations and wages played a key role in whether commodity price
movements altered trend inflation.

2 Readers may be interested in “Oil and the Macroeconomy in a
Changing World,” the proceedings of a 2010 symposium held at the Boston
Fed to explore the interactions between energy prices, growth, and
inflation – the determinants of oil prices and about the effect that oil
prices have on the world economy. The proceedings are available at

http://www.bostonfed.org/economic/conf/oil2010/index.htm

3 Even future purchases can be affected, if saving for them is
squeezed.

4 The Fed’s Large-Scale Asset Purchases have partly, but not
completely, substituted for the constraint imposed by the zero lower
bound on policy easing. With all the excess capacity – a reflection of
our inability to be as accommodative as we might have liked, given the
zero bound – it seems unlikely that supply shocks will turn into
increased inflation expectations that will affect wages and non-oil,
non-food prices. 5 Vice Chair Yellen notes that “a key lesson from the
experience of the late 1960s and 1970s is that the stability of
longer-run inflation expectations cannot be taken for granted. At that
time, the Federal Reserve’s monetary policy framework was opaque, its
measures of resource utilization were flawed, and its policy actions
generally followed a stop-start pattern that undermined public
confidence in the Federal Reserve’s commitment to keep inflation under
control. Consequently, longer-term inflation expectations became
unmoored, and nominal wages and prices spiraled upward as workers sought
compensation for past price increases and as firms responded to
accelerating labor costs with further increases in prices. That
wage-price spiral was eventually arrested by the Federal Reserve under
Chairman Paul Volcker, but only at the cost of a severe recession in the
early 1980s. Since then the Federal Reserve has remained determined to
avoid these mistakes and to keep inflation low and stable.”
[http://www.federalreserve.gov/newsevents/speech/yellen20110411a.htm]

6 The average annual expected price change they expect over the
next 5 to 10 years

7 See for example the comments on commodity price pressures and
monetary policy by my colleague William Dudley, president of the New
York Federal Reserve Bank and Vice Chair of the Federal Open Market
Committee: “Inflation expectations are well-anchored today and we intend
to keep it that way. A sustained rise in medium-term inflation
expectations would represent a threat to our price stability mandate and
would not be tolerated.”

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