How long can the big picture of the job go on? The Fed thinks indefinitely

It is a bold claim. Economic cycles do not die of old age, but over time they develop life-threatening conditions such as inflation or financial imbalances.

Mr. Powell's reading of recent economic history suggests that it will be another time. After the Second World War, extensions generally resulted in inflation and rising interest rates. However, Mr. Powell regularly notes that the last two cases have not done so: the unemployment rate fell below 5% in the 1990s and again in the 2000s without underlying inflation ( which excludes unstable prices for food and energy) by around 2%. This proved that inflation had become much less sensitive to the low unemployment rate in recent decades.

Rather than inflation, the bursting of asset bubbles ended these cycles. So as long as financial imbalances do not recur and that a shock such that a war will not occur, Mr. Powell is convinced that unemployment can remain much lower than in the past without forcing the Fed to stop the expansion with higher interest rates.

Since the 1950s, economists have estimated that when unemployment falls below a minimum natural level, demand for workers, goods and other resources exceeds supply, so that wages and prices rose. This inverse relationship between unemployment and inflation is called the Phillips curve.

Studies by Fed staff conclude that, from the late 1970s to the early 1990s, the Phillips curve was rather steep: a drop in the unemployment rate by one percentage point would increase the number of employees. Inflation: 0.5 to 0.8 percentage points.

By the early 2000s, however, this same drop in unemployment would only increase inflation by a quarter of a point, and by 2017, only a twentieth. In other words, the Phillips curve is now almost flat. Moreover, between the 1970s and the early 1990s, inflation was quite persistent: if it increased from one year to the next, it would tend to stay there the following year. This viscosity is now gone; an increase or decrease in inflation tends to be fleeting.

There is a lot of discussion about why the Phillips curve has flattened and inflation is less stubborn. Fed officials tend to congratulate themselves for having made it clear that they would maintain inflation close to 2%, in any case. This encourages workers and businesses to expect 2% inflation, an expectation that becomes a reality.

Whatever the reason, Mr. Powell and his colleagues think, according to the flat Phillips curve, that the unemployment rate can average 3.5% over the next two years, while inflation exceeds 2% and short-term interest rates remain around 3%.

This prospect "is not too good to be true and does not signal the death of the Phillips curve," he said in a speech in Boston last month. This corresponds to "a very flat Phillips curve and inflation expectations anchored at nearly 2%".

Forecasts are tense: Fed officials believe that the natural unemployment rate is much higher, around 4.5%. This suggests that unemployment should eventually increase considerably, which has never happened without a recession.

Still, Mr. Powell questioned the usefulness of natural rate estimates. In a Jackson Hole speech in August, he pointed out how hard the natural rate is to be determined in real time: it was higher than what was generally assumed in the 1970s and lower in the 1990s. A footnote suggesting that it could be different in the short and long term, implying that the long term estimate of 4.5% has only a little weight in it. the deliberations of the Fed. "What does this long-term natural unemployment rate mean?", He told reporters in September. "It does not create short-term problems for [our] provide."

So, if inflation or any shock does not kill this expansion, what will it be? Powell was more open than his predecessors to raise interest rates to limit the financial excesses that triggered the last two recessions. But in September, he told reporters that he thought the risk of such excesses was only "moderate". Behind this optimistic view, there is the fact that speculative mortgages no longer plague the housing market, a common culprit in financial collapses, and banks, another culprit, having a lot of capital and liquidity absorbing the losses. Real estate loans to businesses and businesses are generally not included in the balance sheets of banks. House prices and stock prices are high, but rightly so given low interest rates.

Is this perspective too bullish? In spite of all the evidence used by Mr. Powell, it amounts to saying that the world "is different this time", often described as the most dangerous words in finance.

The last time unemployment was so low, in the 1960s, inflation broke out almost suddenly. As far as financial excesses are concerned, the latest crisis has erupted outside the banks. Yet, the United States is gradually reducing the tools put in place to deal with such risks.

Mr. Powell knows the dangers of thinking that it is different this time. A footnote to his speech last month indicates that the late economist Herb Stein has advised skepticism of any claim that "the economy [will] Mr. Powell said last month that the Fed wanted to raise interest rates: "If we do not put [probability] overheating, we would not raise rates at all. "

Write to Greg Ip at [email protected]