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How Does the Economy Work? A New Fed Paper Suggests Nobody Really Knows – The New York Times

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Many experts are rethinking longstanding core ideas, including the importance of inflation expectations.

It has long been a central tenet of mainstream economic theory that public fears of inflation tend to be self-fulfilling.

Now though, a cheeky and even gleeful takedown of this idea has emerged from an unlikely source, a senior adviser at the Federal Reserve named Jeremy B. Rudd. His 27-page paper, published as part of the Fed’s Finance and Economics Discussion Series, has become what passes for a viral sensation among economists.

The paper disputes the idea that people’s expectations for future inflation matter much for the level of inflation experienced today. That is especially important right now, in trying to figure out whether the current inflation surge is temporary or not.

But the Rudd paper is part of something bigger still. It reflects a broader rethinking of core ideas about how the economy works and how policymakers, especially at central banks, try to manage things. This shift has also included debates about the relationship between unemployment and inflation, how deficit spending affects the economy, and much more.

In effect, many of the key ideas underlying economic policy during the Great Moderation — the period of relatively steady growth and low inflation from the mid-1980s to 2007 that also seems to be a high-water mark for economists’ overconfidence — increasingly look to be at best incomplete, and at worst wrong.

It is vivid evidence that macroeconomics, despite the thousands of highly intelligent people over centuries who have tried to figure it out, remains, to an uncomfortable degree, a black box. The ways that millions of people bounce off one another — buying and selling, lending and borrowing, intersecting with governments and central banks and businesses and everything else around us — amount to a system so complex that no human fully comprehends it.

“Macroeconomics behaves like we’re doing physics after the quantum revolution, that we really understand at a fundamental level the forces around us,” said Adam Posen, president of the Peterson Institute for International Economics, in an interview. “We’re really at the level of Galileo and Copernicus,” just figuring out the basics of how the universe works.

“It requires more humility and acceptance that not everything fits into one model yet,” he said.

Or put less politely, as Mr. Rudd writes in the first sentence of his paper, “Mainstream economics is replete with ideas that ‘everyone knows’ to be true, but that are actually arrant nonsense.”

One reason for this, he posits: “The economy is a complicated system that is inherently difficult to understand, so propositions like these” — the arrant nonsense in question — “are all that saves us from intellectual nihilism.”

And from that starting point, a staff economist at the world’s most powerful central bank went on to say, in effect, that his own employer has been focused on the wrong things for the last few decades.

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Mainstream policymakers, very much including Mr. Rudd’s bosses at the Fed, believe that inflation is, in large part, self-fulfilling — that what people expect future inflation to look like has an ability to shape how much prices rise in the near term.

In the common telling, the Great Inflation of the 1970s got going because people came to believe inflation would keep spiraling. The surge in gasoline prices wasn’t simply a frustrating development, but a harbinger of things to come, so people needed to demand higher raises, and businesses could feel confident charging higher prices for most everything.

In this story, the great achievement of the Fed in the early 1980s was to break this cycle by re-establishing credibility that it would not allow sustained high inflation (though at the cost of a severe recession).

That is why today’s discussions over the inflation outlook often spend a lot of time focusing on things like what bond prices suggest inflation will be five or 10 years from now, or how people answer survey questions about what they expect.

Mr. Rudd argues that there is no solid evidence that the conventional story of the 1970s describes the real mechanism through which inflation takes place. He says there’s a simpler explanation consistent with the data: that businesses and workers arrive at prices and wages based on the conditions they’ve experienced in the recent past, not some abstract future forecast.

For example, when inflation has been low in the recent past, workers might not demand raises as they would in a world where inflation was high; after all, their existing paychecks go pretty much as far as they used to. You don’t need some theory involving inflation expectations to get there.

Some economists who are sympathetic to the idea that central bankers have overly fetishized precise measurements of inflation expectations aren’t ready to fully dismiss the idea.

For example, Mr. Posen, a former Bank of England policymaker, says there remains a simple and hard-to-dispute idea about inflation expectations supported by lots of history: that if people distrust a country’s monetary system, inflation shocks can spiral upward. Economic policy credibility matters. But that isn’t the same as assuming that some survey or bond market measure of what will happen to inflation in the distant future is particularly meaningful for forecasting the near future.

“It has been a noble lie that has become a critical part of the catechism of global monetary policy, that long-term inflation expectations are not just interesting but are a decisive determinant of real-time inflation,” said Paul McCulley, a former Pimco chief economist, commenting on Mr. Rudd’s paper.

This isn’t the only way in which basic precepts underlying economic policy are shifting beneath economists’ feet.

Particularly prominently, for years central bankers believed there was a tight relationship between the unemployment rate and inflation, known as the Phillips Curve. Over the course of the 2000s, though, that relationship appeared to weaken and become a less reliable guideline for how to set policy.

Similarly, interest rates and inflation fell worldwide, for reasons that scholars are still trying to understand fully. That implied a lower “neutral interest rate,” or the rate that neither stimulates nor slows the economy, than was widely believed to be the case as recently as the mid-2010s.

In many ways, the Fed’s policies just before the pandemic were aimed at incorporating those lessons and embracing sustained lower interest rates — and the possibility of lower unemployment — than many in the mainstream thought reasonable a few years earlier.

In the realm of fiscal policy, some conventional wisdom has also been upended in the last few years. It was thought that large government debt issuance would risk causing a spike in interest rates and crowd out private sector investment. But in that period, huge budget deficits have been paired with low interest rates and abundant credit for businesses.

All of this makes it a challenging time for central bankers and other shapers of policy. “If you’re a policymaker and you don’t have robust confidence in the parameters of the game you are managing, it makes your job a whole lot more difficult,” Mr. McCulley said.

But if you are in charge of making economic policy that affects the lives of millions, you can’t simply shrug your shoulders and say, “We don’t know how the world works, so what are we supposed to do?” You look at the evidence available, and make the best judgment you can.

And then, if you think it turns out you were wrong about something, publish a sassy paper to try to get it right.

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Canada’s unemployment rate holds steady at 6.5% in October, economy adds 15,000 jobs

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OTTAWA – Canada’s unemployment rate held steady at 6.5 per cent last month as hiring remained weak across the economy.

Statistics Canada’s labour force survey on Friday said employment rose by a modest 15,000 jobs in October.

Business, building and support services saw the largest gain in employment.

Meanwhile, finance, insurance, real estate, rental and leasing experienced the largest decline.

Many economists see weakness in the job market continuing in the short term, before the Bank of Canada’s interest rate cuts spark a rebound in economic growth next year.

Despite ongoing softness in the labour market, however, strong wage growth has raged on in Canada. Average hourly wages in October grew 4.9 per cent from a year ago, reaching $35.76.

Friday’s report also shed some light on the financial health of households.

According to the agency, 28.8 per cent of Canadians aged 15 or older were living in a household that had difficulty meeting financial needs – like food and housing – in the previous four weeks.

That was down from 33.1 per cent in October 2023 and 35.5 per cent in October 2022, but still above the 20.4 per cent figure recorded in October 2020.

People living in a rented home were more likely to report difficulty meeting financial needs, with nearly four in 10 reporting that was the case.

That compares with just under a quarter of those living in an owned home by a household member.

Immigrants were also more likely to report facing financial strain last month, with about four out of 10 immigrants who landed in the last year doing so.

That compares with about three in 10 more established immigrants and one in four of people born in Canada.

This report by The Canadian Press was first published Nov. 8, 2024.

The Canadian Press. All rights reserved.

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Health-care spending expected to outpace economy and reach $372 billion in 2024: CIHI

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The Canadian Institute for Health Information says health-care spending in Canada is projected to reach a new high in 2024.

The annual report released Thursday says total health spending is expected to hit $372 billion, or $9,054 per Canadian.

CIHI’s national analysis predicts expenditures will rise by 5.7 per cent in 2024, compared to 4.5 per cent in 2023 and 1.7 per cent in 2022.

This year’s health spending is estimated to represent 12.4 per cent of Canada’s gross domestic product. Excluding two years of the pandemic, it would be the highest ratio in the country’s history.

While it’s not unusual for health expenditures to outpace economic growth, the report says this could be the case for the next several years due to Canada’s growing population and its aging demographic.

Canada’s per capita spending on health care in 2022 was among the highest in the world, but still less than countries such as the United States and Sweden.

The report notes that the Canadian dental and pharmacare plans could push health-care spending even further as more people who previously couldn’t afford these services start using them.

This report by The Canadian Press was first published Nov. 7, 2024.

Canadian Press health coverage receives support through a partnership with the Canadian Medical Association. CP is solely responsible for this content.

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Trump’s victory sparks concerns over ripple effect on Canadian economy

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As Canadians wake up to news that Donald Trump will return to the White House, the president-elect’s protectionist stance is casting a spotlight on what effect his second term will have on Canada-U.S. economic ties.

Some Canadian business leaders have expressed worry over Trump’s promise to introduce a universal 10 per cent tariff on all American imports.

A Canadian Chamber of Commerce report released last month suggested those tariffs would shrink the Canadian economy, resulting in around $30 billion per year in economic costs.

More than 77 per cent of Canadian exports go to the U.S.

Canada’s manufacturing sector faces the biggest risk should Trump push forward on imposing broad tariffs, said Canadian Manufacturers and Exporters president and CEO Dennis Darby. He said the sector is the “most trade-exposed” within Canada.

“It’s in the U.S.’s best interest, it’s in our best interest, but most importantly for consumers across North America, that we’re able to trade goods, materials, ingredients, as we have under the trade agreements,” Darby said in an interview.

“It’s a more complex or complicated outcome than it would have been with the Democrats, but we’ve had to deal with this before and we’re going to do our best to deal with it again.”

American economists have also warned Trump’s plan could cause inflation and possibly a recession, which could have ripple effects in Canada.

It’s consumers who will ultimately feel the burden of any inflationary effect caused by broad tariffs, said Darby.

“A tariff tends to raise costs, and it ultimately raises prices, so that’s something that we have to be prepared for,” he said.

“It could tilt production mandates. A tariff makes goods more expensive, but on the same token, it also will make inputs for the U.S. more expensive.”

A report last month by TD economist Marc Ercolao said research shows a full-scale implementation of Trump’s tariff plan could lead to a near-five per cent reduction in Canadian export volumes to the U.S. by early-2027, relative to current baseline forecasts.

Retaliation by Canada would also increase costs for domestic producers, and push import volumes lower in the process.

“Slowing import activity mitigates some of the negative net trade impact on total GDP enough to avoid a technical recession, but still produces a period of extended stagnation through 2025 and 2026,” Ercolao said.

Since the Canada-United States-Mexico Agreement came into effect in 2020, trade between Canada and the U.S. has surged by 46 per cent, according to the Toronto Region Board of Trade.

With that deal is up for review in 2026, Canadian Chamber of Commerce president and CEO Candace Laing said the Canadian government “must collaborate effectively with the Trump administration to preserve and strengthen our bilateral economic partnership.”

“With an impressive $3.6 billion in daily trade, Canada and the United States are each other’s closest international partners. The secure and efficient flow of goods and people across our border … remains essential for the economies of both countries,” she said in a statement.

“By resisting tariffs and trade barriers that will only raise prices and hurt consumers in both countries, Canada and the United States can strengthen resilient cross-border supply chains that enhance our shared economic security.”

This report by The Canadian Press was first published Nov. 6, 2024.

The Canadian Press. All rights reserved.

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