US policy makers count on Phillips curve to lift inflation back to their goal
Atlanta — Janet Yellen said in December that her main unfinished business as chairwoman of the Federal Reserve was getting inflation back to the central bank’s 2% target.
A return to her former home in the San Francisco Bay Area would solve that.
Metropolitan areas in the western US, those with more than 1.5-million residents, posted 3.4% inflation over the past year. That includes 2.9% in San Francisco, 3.5% in Seattle and 3.6% in Los Angeles, the government reported on January 12. By contrast, larger metro areas in the northeast and midwest registered price gains of less than 2%, while in the south it was 2.1%.
The Fed targets national inflation and puts less weight on regional disparities such as those in the West, where housing prices are surging and local job markets are booming, partly as a result of technology-industry riches. On the other hand, policy makers are counting on that relationship between unemployment and price pressures, known as the Phillips curve, to lift inflation back to their goal.
"That the strong cities are seeing an uptick in inflation suggests the direction that the national economy will be heading over time," said Stephen Stanley, chief economist at Amherst Pierpont Securities and a former researcher at the Federal Reserve Bank of Richmond. "The cities and states that are stronger will get there sooner."
US consumers can have vastly different experiences with inflation depending on what’s purchased and where.
"Much of the disparity in these regional CPIs can be tied to differences in rents both for renters and homeowners alike," said Brent Meyer, policy adviser and economist at the Atlanta Fed, who put together the bank’s "myCPI" tool that allows individuals to calculate individualised measures of inflation.
Owners’ equivalent rent, or the implicit rent a homeowner would earn from leasing the property, rose 4% in San Francisco, 4.4% in Los Angeles and 6.6% in Seattle. While US population growth has slowed in recent years, the West has been roaring. Idaho, Nevada, Utah and Washington posted the biggest percentage gains in 2017 from a year earlier, according to the latest Census Bureau data.
The West has "very strong job growth, combined with inadequate housing supply and new construction, especially in California," said Lawrence Yun, chief economist at the National Association of Realtors in Washington. "Because of very high home prices in California, workers and companies are moving to nearby states, which is also fueling their housing market and rents."
Greg Jones, a musician and retail worker in Oakland, has been looking for an apartment and is shocked at how much rents have risen in recent years, with a small bedroom in someone else’s house going for $1,500 a month. One advertisement indicated the tenant shouldn’t use the home’s kitchen, while another studio apartment was available to "vegetarians only", Jones said.
"This is ridiculous and out of control," he said. "It gets worse by the month. It gets more and more expensive."
In December, Fed policy makers penciled in three rate hikes for 2018 to ensure that a tight labour market did not lead to price surges or financial instability, even as inflation has remained below target. Investors expect a rate increase at the March 20-21 meeting, which would be the first under a new chairperson, Jerome Powell, nominated by US President Donald Trump.
The Phillips curve suggests there’s a relationship between tightening labour markets and rising prices, meaning the current 4.1% US unemployment rate should be generating higher wages and inflation. Fed leaders have been perplexed because prices, as measured by their preferred measure that’s tied to spending, have gained less than 2% almost every month since around mid-2012.
Looking at cities, though, there’s some evidence the link is not broken. Fed research in 2014 by economist Michael Kiley that examined 24 large metro areas since 1985 found "the Phillips curve is very strong across metropolitan areas".
Still, the relationship isn’t perfect and there are exceptions. The St Louis Fed has looked for "Phillips curve effects" by counties and metro areas in the bank’s district that includes Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.
"It is not as much correlation as you would think," St Louis Fed president James Bullard said last week. The research hasn’t been published.
Bullard has been among the Fed policy doves arguing against rate hikes until inflation starts rising closer to target. On a national level, labour market effects on wages and prices seem minimal, he said.
In the West, though, the higher inflation is coinciding with glowing labour markets. Jobs in Utah were up 2.8% in the year through November, while payrolls increased 2% or more in Nevada, Oregon, Idaho and Washington, labour department figures show. Employment in California rose 1.7%, still above the national rate.
In the south, Atlanta is among cities with the strongest job growth and faster inflation. Employment was up 2.1% in November from the same month a year earlier, while prices increased 3.2% in the 12 months through December.
"Places with tight labour markets have higher inflation," said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore and a former Fed economist. Economists have had "perhaps more luck in finding a Phillips curve than you get with the national data".