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Transcript

Tim Sablik: Hello, and welcome to Speaking of the Economy. I'm your host, Tim Sablik, a senior economics writer at the Richmond Fed.

My guest today is Renee Haltom. Renee is vice president and the regional executive covering Virginia. Renee, welcome back to the show.

Renee Haltom: It's great to be back with you.

Sablik: Today's conversation is a part of a series of interviews that I'll be doing with the Richmond Fed's regional executives on the state of our regional economy. Our regional executives maintain contact with business leaders in their area, helping the Bank keep up to date on economic conditions on the ground.

Renee, I thought a good place to start would be with inflation. At the start of this year, there was a lot of talk about supply chain disruptions driving prices higher in certain sectors. Since then, inflation has become more widespread and the Fed is responding to cool things off on the demand side. What are you hearing about inflation from your contacts, and is the tightening by the Fed already starting to have an effect?

Haltom: In a word, yes.

Just to set the stage, one thing characterizing the inflation we've seen in the last 12 to 18 months is simply that demand has been way ahead of supply. During the pandemic we stayed home [and] we bought things online at the same time that fiscal and monetary stimulus made it easier to spend. Also, at the same time, supply chains were disrupted by the pandemic. It was really hard to supply all the goods we were demanding. That's the gist of why we saw inflation.

I say all that because it follows that for inflation to end, we need to see those conditions change and supply and demand come back into better balance. The Fed's policy tool of interest rates works through the demand side, as you said, and we are starting to see demand attenuate some.

We're constantly talking to business contacts to track the economy, and we are hearing early signs of slowing. But I'd say it's not yet broad-based. Services spending, for example, is still doing well, whereas there's more of a slowdown in goods it seems.

One place I'm hearing it most is in durable goods, specifically a set of goods that are targeted to lower income consumers. And even there, it's probably not higher interest rates having the effects just yet. It's more that those households are seeing their purchasing power eroded by inflation. If you're spending more at the pump or buying groceries, you may have less available for new washing machines or TVs. Many of those households stocked up on durable goods during the pandemic, so it's the first thing they'll be cautious about when budgets start to feel tighter.

As for the contacts at the forefront of that slowdown, in terms of how this affects inflation itself, they do expect price pressures to come down to the extent that demand comes down. You're hearing stories and this is in the news, and I certainly hear it from contacts, stories about inventories booming and expectations of the need potentially to discount and cut prices to move that inventory.

You're seeing some of that reduced price pressure in actuality. But like the slowdown, it doesn't feel widespread yet. So far, it's a bit more talking about the potential need to cut prices than they've actually happening.

Sablik: Yeah, I've been reading similar stories about inventory that you mentioned. I think another area of the economy that's had this supply-demand mismatch that you're talking about is definitely the housing market. We've seen mortgage rates go up recently — they've nearly doubled on average since the early parts of the pandemic. What impact is that having on housing demand and the overall pricing situation there?

Haltom: Housing demand has definitely slowed, though I'll remind listeners that this is probably welcome to some. It's not necessarily healthy to have 20 cash offers for every available home out there, much less positive about the housing slowdown. It's hitting hardest, based on what contacts say, at the lower end of the housing market, meaning people buying starter homes and the like since higher interest rates impact housing affordability and monthly payments.

Demand has also slowed at the higher end of the housing market. But those shoppers tend to have more savings or equity available to help with a purchase. What I'm hearing from home builders [is] that it's gone from 20 buyers for every house to five or six.

One positive thing is that the lower degree of froth in housing is helping to attenuate house price appreciation. But it's important to note that we also have, as you said, extremely low housing inventory in most parts of the country. So, demand is still perceived as way ahead of supply in housing, at least for now.

My contacts in homebuilding still say materials are really hard to get and supply chains in building are as disrupted as ever. Building costs are, in fact, still going up, which hurts … in terms of making the decision to build new homes. I think that reflects long lags in homebuilding. It's going to take some working through of existing backlogs for homebuilding and construction to feel the full relief and supply chains in building costs as that demand sort of attenuates.

This is just one reason, of course, why we always say that monetary policy affects the economy and inflation with long and variable lags. As much as we wish we could raise interest rates and bring inflation down immediately, it just doesn't work that quickly. So, we have to watch the data and talk with contacts over a long period of time to really assess how our policy changes are affecting inflation.

Sablik: Right.

I know another area that the Fed is watching closely is the labor market. The story, last year and into this year, is that workers were seemingly incredibly hard to find. A lot of employers reported trouble finding workers. What have you been hearing on that front? Are companies still having to raise wages to attract new hires, as well as respond to the inflation environment?

Haltom: Wages are a really important thing to bring up in the context of inflation. They are an important cost of producing things.

As you know, labor [supply] has been incredibly tight for a lot of the pandemic. As a result, predictably, employers have driven up wages to attract workers, especially in those high-touch sectors where people just weren't sure they wanted to work in a highly contagious pandemic.

The good news now is that wage pressure, outside of extreme shortage sectors, seems to have alleviated some. As news stories alluded to, the labor shortage is coming down a bit. There's still a few places where workers are just incredibly difficult to find, most notably in skilled trades, for example, including health professions. Naturally, wage pressure has come down some in terms of new hires.

Nowadays, what I'm more likely to hear from contacts is about catch-up wage inflation from wage compression. What that means is there's a need to catch up existing employees to all those new employees they hired at elevated wages. They want to do that for equity reasons internally and for morale. For that reason, there is actually still a good bit of wage pressure out there.

Inflation itself is another factor in wages. You hear employers say that workers are complaining about inflation and they would like to be compensated more. I would say we are not yet in a wage price spiral, at least based on what contacts are telling me.

Sablik: Yeah, that's definitely something to watch.

It raises a good point about how households are responding to inflation. What have you heard in terms of how inflation affects different households differently and how they're responding to this situation?

Haltom: Yeah, that's a really important question with a lot of possible answers. It's really important for the Fed as it thinks about inflation to understand how it affects different households and businesses differently.

For households, one thing it depends on is the basket of goods that people consume each month. We know that, for example, lower income households spend a larger share of their income on the very goods whose prices have risen. There's more research on this on the Fed's website.

I'd love to highlight a particular aspect of this, and that's differential effects by geography. At the Richmond Fed, we spend a lot of time in rural areas since we have a lot of rural parts of our district. We've really been on a mission to understand those parts of our district better.

There are ways that inflation is more significant there. It's the fact that rural areas lack density. That already makes it harder to provide services like housing and transportation and food and childcare. Inflation has made those issues even more distinct in rural places. Moreover, in rural areas, you tend to have to drive further to work or to access services, so the spike in gas prices has hit really hard.

Richmond Fed President Tom Barkin and I were recently visiting southern Virginia. We heard everywhere we went the significant impacts that inflation was having. In some cases, we heard that inflation is actually driving workers out of the labor force. Once you factor in transportation and the cost of childcare, some workers are just saying forget it, working isn't worth it.

Sablik: Right.

Well, I think that's a great overview of many of the topics that you and others at the Fed are paying attention to. I'd like to ask if there's anything that you'll be watching in particular in the next months as we close out this year.

Haltom: Absolutely. For all the concern about what rising interest rates will do to demand and housing affordability and even the possibility of recession, which is coming up more and more as the Fed raises rates, inflation is really challenging and harmful, too.

The long arc of Fed history tells us that we have to act with conviction to get inflation under control. That lessons even worse outcomes down the road if we're able to do that. When I talk to businesses, for as much as they may say that they don't like a slowing economy or higher interest rates, most are even more concerned about inflation.

The main thing we're watching is how quickly inflation comes down and whether inflation expectations stay anchored. Going forward, that's a big clue as to how much higher the Fed needs to raise interest rates and how quickly. That's one of the reasons we really value these conversations we have with businesses around our District because it really is the first earliest signal of that question.

Sablik: Yeah. I definitely value and appreciate you being here today to share what you've been hearing in those conversations. Thanks very much for joining me, Renee.

Haltom: It's great to be here. Thanks again.

Sablik: I'll remind our listeners to stay tuned through the month of August to all the chats with our regional executives to hear what's happening in our economy.