Surges of foreign investment into developing countries can amplify economic stress and potentially undermine their financial stability. New evidence suggests that excessive foreign capital inflows can also increase income inequality in emerging economies. Research shows that, as low global interest rates trigger more investment, those inflow surges benefit entrepreneurs by raising their returns, while lowering household earnings on bank deposits within the countries. The potential impact on income inequality provides another reason beyond financial stability for resisting abrupt surges in capital inflows.
Unemployment fell at a slow and steady rate in the 10 cyclical recoveries from 1949 through 2019. These historical patterns also apply to the recovery from the pandemic recession after accounting for the unprecedented burst of temporary layoffs early in the pandemic followed by their rapid reversal from April to November 2020. Unemployment for other reasons—which has been most important in other recent recoveries—did not start declining until November 2020. Since then, unemployment for other reasons has declined at a faster pace than its historical average.
The relationship between economic activity and local COVID-19 conditions—infections and deaths—has changed over time. While activity was strongly tied to local virus conditions during the first six to nine months of the pandemic, they decoupled in late 2020 through the first half of 2021. This link strengthened again in the third quarter of 2021, particularly for highly vaccinated counties. One possible interpretation of this restrengthening is that areas with high vaccination rates have heightened virus risk aversion and hence high sensitivity to changes in local virus conditions.
Racial disparities in socioeconomic outcomes for the U.S. population are often masked by aggregate statistics. Unemployment rates vary significantly across groups according to gender and race or ethnicity and have different sensitivities to the business cycle. Focusing on jobless rates by demographic groups shows that Black and Hispanic workers, particularly men, are the most sensitive to periods of economic growth and decline. This higher sensitivity persists across individuals with the same education level. Occupation plays a role in explaining the relative cyclical differences in unemployment rates across demographic groups.
U.S. labor productivity has grown quickly during the pandemic compared with the past decade. However, this rapid pace is unlikely to be sustained. Similar to the Great Recession, the primary reasons for strong productivity growth now are cyclical effects that are likely to unwind as the economy continues to recover. For example, the number of workers has fallen, so capital per worker has risen—raising labor productivity in the short term. What effect the pandemic itself might have on productivity remains uncertain.
While the severity and scope of a changing climate remains unclear, the consensus is that it poses a significant risk to the global economy and financial system. As monetary policymakers, the Fed’s job is to navigate this uncertainty by anticipating the potential changes and understanding their implications. The following is adapted from remarks by the president of the Federal Reserve Bank of San Francisco to the Peterson Institute for International Economics on June 22.
The American Rescue Plan provided fiscal support during a strong economic rebound, raising concerns about the risk of fueling inflation. One way to assess this risk of economic overheating uses the ratio of job vacancies to unemployment, which measures labor market slack more accurately and, hence, can predict future inflation better than the unemployment rate alone. Estimates suggest that the fiscal plan acts to temporarily raise the vacancy-to- unemployment ratio, in turn pushing up inflation by about 0.3 percentage point per year through 2022.
The COVID-19 pandemic has caused massive disruptions to the U.S. educational system. Research on school closures—particularly combined with parental income loss—implies that children are likely to attain lower levels of lifetime education compared with pre-pandemic trends. Projections show learning disruptions could lower the level of annual economic output ¼ percentage point on average over the next 70 years. The effect is small the first 5–10 years then peaks at a loss of ½ percentage point in about 25 years, when the children reach prime working age.
Uncertainty about U.S. climate policy in the future creates risk that affects the investment decisions businesses make today. If firms expect future policy to raise the cost of carbon emissions, then they could react to this by both shifting investment towards cleaner capital and reducing overall investment. These two responses lead to lower emissions, even if no actual climate policy is in place. Evidence suggests that this risk encourages companies to voluntarily reduce emissions using internal carbon prices and other mechanisms.
Widespread job losses starting in mid-March last year forced many households to rely more heavily on nonemployment income and liquid assets on hand to continue buying what they needed. Federal assistance through the Coronavirus Aid, Relief, and Economic Security Act helped boost household resilience—the ability to sustain consumption despite the loss of employment income. Data suggest that the aid increased household resilience by 15 weeks, chiefly through enhanced unemployment insurance benefits. Among racial groups, this benefited Black and Hispanic households the most, raising median household resilience by 19 weeks.
Household surveys indicate that consumers expect higher inflation this year than in recent years, as the U.S. economy rebounds from the deep recession. This has coincided with a surge in commodity prices, as strong demand for goods like gas, food, and construction materials is catching producers with low supplies. Evidence suggests that households respond to commodity price increases by raising their expectations of future inflation. However, since surges in commodity prices are transitory, their effects on inflation expectations—particularly long-term expectations—are modest and short-lived.
The COVID-19 pandemic disproportionately affected the health and financial well-being of communities of color. Over the past year, minority banks that specialize in providing financial services to underserved communities and minority borrowers have also performed significantly worse than other banks of similar size. Minority banks projected higher loan losses and had lower profits than nonminority banks. To the extent that underperforming minority banks may be more reluctant to expand lending—whether to avoid risk or minimize regulatory scrutiny—it could further exacerbate the unevenness of the recovery.
Investors are usually willing to pay a higher price, known as a premium, for a safe fixed-income asset in return for the convenience of its high quality and liquidity. A study of Swiss government bonds—widely considered to be extremely safe but not particularly liquid—can give some insights into how quality affects the premium. The large and variable safety premium of these bonds surged to persistently higher levels following the launch of the euro. However, subsequent large asset purchases by the European Central Bank depressed the safety premium.
Disagreement among economic forecasters about the outlook for inflation in both the United States and the euro area has increased since the onset of the pandemic. The nature of these forecast differences can provide insights into the inflation risks that lie ahead. Many forecasters initially expected substantially lower inflation over the next year but subsequently raised their expectations as economic activity began to improve. In contrast, changes in expectations and disagreement about longer-term inflation have been relatively subdued and suggest a balanced likelihood between higher and lower inflation.
