A 1998 Paper May Yield Clues to Powell’s Themes for Jackson Hole

Wind back the clock 20 years, and the U.S. economy looked a lot like it does today.

(Bloomberg) -- Wind back the clock 20 years, and the U.S. economy looked a lot like it does today.

Unemployment in May 1998 was 4.3 percent and core inflation was 2.2 percent. Economists were trying hard to figure out why such low unemployment hadn’t led to higher inflation, as predicted by the past.

At the time, the 1990s productivity miracle, associated with the rise of personal computers and the Internet in the workplace, was all the rage in research circles. The following month, in June 1998, the Bank of Japan convened a conference to examine the implications for monetary policy.

One of the papers presented in Tokyo was authored by James Stock, an influential economist whose work has shaped the quantitative techniques used in the field. The title was “Monetary Policy in a Changing Economy.”

On Friday, Fed Chairman Jerome Powell is scheduled to give a speech at an annual gathering of central bankers in Jackson Hole, Wyoming, bearing the same title as Stock’s 1998 paper.

More Aggressive

And in light of the backdrop -- unemployment in July was 3.9 percent, while core inflation was 2.4 percent -- Fed officials may find the counterintuitive conclusion Stock arrived at 20 years ago is still relevant. Namely, if as a central banker you’re unsure about whether the economy has changed in fundamental ways, it pays to be more aggressive, not less.

The theme of this year’s Jackson Hole confab sounds eerily similar to that of the 1998 conference. Two decades later, policy makers will still be discussing “dynamics that have contributed to shifts in productivity, growth and inflation” as a result of technology and globalization, according to the Kansas City Fed, which hosts the event.

The debate about structural changes in economic activity will color the biggest question facing investors in 2018: how high will the Fed raise interest rates in the coming years?

The U.S. central bank started increasing rates in December 2015 and the current target range is 1.75 percent to 2 percent. According to projections in June, officials expect they will lift the range to 3 percent to 3.25 percent by the end of next year, and to 3.25 percent to 3.5 percent by the end of 2020.

The Problem

That means sometime next year, they will raise rates above the their estimates of the so-called neutral interest rate which neither boosts nor restricts economic growth -- most Fed officials believe it’s somewhere between 2.5 and 3 percent. That makes sense because, according to their models, unemployment is below their estimate of the so-called natural rate of unemployment which would keep inflation stable. In June, they believed that rate was 4.5 percent.

But the problem facing Fed officials is that even though unemployment is at the lowest levels in nearly 20 years, inflation isn’t showing many signs of a pickup.

One of the most common explanations is that policy makers’ views of the natural rate of unemployment may be too high. The error bands around those estimates are “two percentage points on either side,” Chicago Fed President Charles Evans said Aug. 9.

A 1998 Paper May Yield Clues to Powell’s Themes for Jackson Hole

In other words, it’s possible that unemployment could fall as low as 2.5 percent without putting upward pressure on prices. That might suggest being more cautious with rate hikes than otherwise. And some officials, like Minneapolis Fed President Neel Kashkari and St. Louis Fed President James Bullard, are advocating just that.

Stock’s 1998 paper is all about what central bankers should do in such a situation. He crunched the numbers on how various rate strategies perform when such things as the natural rate of unemployment -- and the relationship between interest rates and unemployment -- are unknown, possibly because they’ve changed over time.

“The results are surprising,” Stock wrote. “A monetary authority facing uncertainty about how the economy is evolving should be willing to pursue policies that are somewhat more aggressive” because such an approach “guards against the possibility that monetary policy is less effective” than a model without uncertainty would suggest.

On Thursday, just ahead of Powell’s speech, the Fed published a paper on the same topic, authored by top economists at the central bank. In it, the authors warned that even though there is uncertainty about estimates of the natural rate of unemployment, it’s still better to set rates based on those estimates than to just wait for inflation to show up.

That logic helps explain why Fed officials’ projections suggest they will probably keep raising rates once they get to neutral levels next year. Powell’s Jackson Hole speech on Friday may indicate whether he agrees.

To contact the reporter on this story: Matthew Boesler in New York at

To contact the editors responsible for this story: Brendan Murray at, Alister Bull, Randall Woods

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