2013 Annual Report

Why Inflation Is Very Low, and Why It Matters

Read the complete 2013 Annual Report of the Federal Reserve of Cleveland.

The Bank's research staff has made tremendous contributions to our understanding of inflation.
Sandy Pianalto

President's Letter

Keeping inflation in check

One of the Federal Reserve’s mandates is maintaining stable prices. During my more than three decades in the Federal Reserve System, the focus has been primarily on avoiding high and variable inflation, and over most of that period, the Federal Reserve has successfully fulfilled its objective to keep inflation in check. More recently, however, our attention has turned to a less familiar concern—persistently low inflation. While high inflation has well-known costs for economic performance, the problems posed by persistently low inflation can be equally harmful. As its title promises, this year’s annual report essay examines why inflation is low, and why it matters.

First, our researchers explore the relatively new phenomenon of low inflation. High inflation rates have been the focus of attention for the last several decades. It has been only in the aftermath of the most recent financial crisis that the Federal Reserve has had to look more carefully at how to guard against both overshooting and undershooting our inflation objective.

Our researchers explain why the US economy is currently experiencing a bout of sustained low inflation. Using a range of tools, our researchers have identified two main sources: slow economic growth, which has put very little upward pressure on prices and wages; and special, temporary forces that have held back some prices, such as the deceleration of medical care costs.

Finally, our researchers discuss appropriate monetary policy responses to persistently low inflation. Crucially, appropriate responses depend on the underlying forecast for inflation. Our current forecast is that steady economic growth should gradually push up inflation toward the Federal Open Market Committee’s longer-run objective of 2 percent, particularly as some temporary forces that had been dampening inflation fade.

Over the past decade, the Bank's research staff has made tremendous contributions to our understanding of inflation. This year’s annual report essay synthesizes and updates some of their most recent work, which we have also put on display in our new Inflation Central website at www.clevelandfed.org/inflation-central. I hope you will find that site a valuable source of information on all things inflation, and I am sure you will see why the Federal Reserve Bank of Cleveland has developed a well-deserved reputation for meaningful and impactful inflation research.

A new strategic plan

The Bank’s inflation research is just one example of how we are fulfilling our mission to foster the stability, integrity, and efficiency of the nation’s monetary, financial, and payments systems. In fact, based on our employees’ wide range of expertise, we rolled out in 2013 a new strategic plan that capitalizes on their many talents. From bank supervision to payments innovation to stakeholder engagement, the Bank’s 2014–2016 strategic plan is bold, aspirational, and focused on the future. First Vice President Greg Stefani talks more about the plan in his letter . I also invite you to watch our “By the Numbers” video, and see how we stacked up in 2013. I think you’ll like what you see.

Guidance and support

In 2013 as always, the Bank’s boards of directors in Cleveland, Cincinnati, and Pittsburgh and its many advisory councils were vital in guiding and supporting our progress. They provide the Federal Reserve with crucial, real-time information about business conditions on the ground, help us pick up trends before they are reflected in the data, and help us make connections with other business leaders in the region. Our directors also oversee many aspects of the Bank, and in 2013 they were instrumental in helping to set the Bank’s strategic direction. I would like to say a special thank you to the four directors who completed their terms in office at the end of 2013 and to our retiring Federal Advisory Council member:

Paul G. Greig, chairman, president, and CEO of FirstMerit Corporation, who served three years on the Cleveland board, and who will serve as the Bank’s Federal Advisory Council representative in 2014
Peter S. Strange, chairman of Messer, Inc., who served six years on the Cincinnati Branch board, the last two years as chairman
Glenn R. Mahone, partner and attorney at law at Reed Smith LLP, who served six years on the Pittsburgh Branch board, the last two years as chairman
Todd D. Brice, president and CEO of S&T Bancorp, Inc., who served on our Pittsburgh Branch board for six years
James E. Rohr, executive chairman of PNC Financial Services Group, Inc., who served three years on our Cleveland Board and three years as the Fourth District’s representative to the Federal Advisory Council, of which he served as chair in 2013

A legacy

It has been 11 years since I participated in my first meeting of the Federal Open Market Committee as the incoming president and CEO of the Federal Reserve Bank of Cleveland. Little did I know back then what was in store for the nation’s economy. The financial crisis, severe recession, and slow recovery have been a challenging and humbling experience, and it has been an honor to represent the Fourth Federal Reserve District during this extraordinary period in our country’s economic history. The one constant during my entire tenure at the Bank has been the extraordinary dedication and professionalism of the employees of the Federal Reserve Bank of Cleveland. As I get ready to retire from the Bank, I know this fine organization is in good hands.

It also gives me great comfort to know that I do not have to say goodbye. We have a term for current and former employees, directors, and advisory council members—we are Fed Family. Once a member, always a member.

Sandra Pianalto
President and Chief Executive Officer

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We are reasonably confident that inflation will rise gradually over the next few years toward the FOMC's longer-run objective of 2 percent.

Why Inflation Is Very Low, and Why It Matters
Vice President of Economic Forecasting    
Vice President of Macroeconomic Policy    


Guarding against inflation

For the past 50 years or so, US policymakers frequently worried about—and fought against—inflation rates running at higher-than-desired levels. But since the financial crisis, they have had to deal with the opposite problem—inflation that is too low.

Inflation fell below 1 percent in 2013, according to the personal consumption expenditures (PCE) price index. At just under half the 2 percent longer-run objective of the Federal Open Market Committee (FOMC), a very low inflation rate is not good news. Often, low inflation is a symptom of an economy that is not firing on all cylinders. And when inflation is very low, deflation is only one adverse shock away.

In this essay, we dissect the recent decline in inflation and lay out its implications for the future, drawing on extensive research done here at the Federal Reserve Bank of Cleveland on inflation measurement and forecasting.

We are reasonably confident that inflation will rise gradually over the next few years toward the FOMC's longer-run objective of 2 percent. However, though the US economy has begun to regain its footing, the inflation forecast could change if unexpected events occur. Our recent experience with very low inflation has highlighted the need to guard against inflation rates that are too low as vigilantly as we guard against inflation rates that are too high.

Inflation is a general rise in prices across the board. It affects all prices, not just a few.

Inflation 101

A beginner’s guide

To many, inflation tends to be an abstract concept. In Inflation 101, we explain the basics of this complex topic in an effort to better connect the work we do with the economic well-being of Americans.

Educational attainment is a partial explanation for employment changes that have taken place during the recovery.

State of the Region

A focus on the Fourth District’s labor market

The Federal Reserve Bank of Cleveland serves the Fourth Federal Reserve District, which comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia. In 2013, the pace of recovery in the region’s labor market began to lag the nation’s. Research suggests that employment performance is linked to educational attainment, and that a region’s longer-run economic prospects are tied to the value of their workers’ skill levels.

It is possible to achieve great things from humble beginnings when you utilize your talents and follow your passions.
Sandy Pianalto

Presidential Milestones

Ten milestones in Sandy Pianalto’s life at the Federal Reserve

1. First Day at the Federal Reserve
In August 1976, a newly hired research assistant named Sandy Pianalto got a tour of the Federal Reserve Board of Governors' Eccles Building in Washington, DC. The high point of the tour was the board room where the Federal Open Market Committee meets. For Pianalto, an immigrant to the United States at age five who had decided early on that she would dedicate herself to public service, it was a career-changing moment. “I was impressed with the huge mahogany table in the center of the room,” she later said. “And I thought to myself, I would love to sit at that table someday.”

2. Appointed to No. 2 Post at the Federal Reserve Bank of Cleveland
Pianalto’s journey to eventually get a seat at that table took a leap forward in 1993. To the surprise of many of her more senior colleagues, Pianalto was named first vice president and chief operating officer (COO) of the Federal Reserve Bank of Cleveland, the Bank’s second–highest–ranking official. Having worked at the Bank for the previous 10 years with increasing responsibilities—though no operations experience—Pianalto began with an ambitious vision. First up was changing the culture of the tradition-bound institution. Some of the differences were symbolic, such as opening up the officers’ dining room to all employees. Others involved driving new behaviors and were longer in the making, such as moving away from a command-and-control style of management to a more participative, collaborative style, and breaking down silos. The goal was to build an inclusive workplace where employees were encouraged to share their ideas.

3. Victory Over Y2K
It felt like a century’s worth of preparation crammed into a few months. Everything was tested—internal operations, software applications, building systems, electro-nic payments, check processing, and cash processing. Across the Federal Reserve System, 90 million lines of code were examined, with about 10 percent remediated before the changeover. The Federal Reserve System distributed billions of dollars in currency as a backstop. Pianalto herself spent New Year’s Eve at the Bank along with dozens of colleagues (sans champagne). They rang in the New Year with nary a glitch. In hindsight, there were people who suggested that Y2K was never a serious threat in the first place. But Pianalto and others on the front lines would be the first to say that the reason it turned out to be a non-event—within the financial services industry, at least—was directly attributable to the work done by the Federal Reserve and the financial services industry more broadly.

4. Leading a Payments Evolution, Part One
In 1997, Pianalto was appointed staff director for the Committee on the Federal Reserve in the Payments Mechanism, a Federal Reserve–commissioned review chaired by Vice Chair Alice Rivlin, to study the future role the Federal Reserve should have in the payments system. The committee reached two general conclusions: The Federal Reserve should remain a provider of both check collection and automated clearing house services, while ensuring access for all depository institutions; the Federal Reserve should play a more active role in enhancing the efficiency of those payments services and helping to evolve strategies for moving to the next generation of payment instruments. The Rivlin Committee was lauded for drawing on the expertise of a range of subject matter experts inside and outside of the Federal Reserve System, reflecting a collaborative spirit that would become Pianalto’s hallmark.

5. Rallying on 9/11
In many ways, days like September 11, 2001, were what the Fed was created for—as a stabilizing force during trying times. Financial markets across the globe were impaired and consumer confidence was threatened after the terrorist attacks. Pianalto, who was still the first vice president and COO at the time, joined conference calls with colleagues across the Federal Reserve and made the decision locally with President Jerry Jordan to keep the Federal Reserve Bank of Cleveland open for business. In the days that followed, the Federal Reserve Bank of Cleveland lent millions of dollars through its discount window to banks impacted by the disruptions to financial markets that occurred following the attacks. Throughout, the Bank’s operations remained fully functional, with no disruption in processing of currency, checks, and electronic payments. Pianalto observed: “It’s times like this when we truly see that our Bank motto, ‘Our people make the difference,’ is more than just words on paper—it’s a reality.”

6. Presidential Timbre
On February 1, 2003, Pianalto became the 10th president and CEO of the Federal Reserve Bank of Cleveland, succeeding the retiring Jerry Jordan. The announcement of her appointment in the Bank’s auditorium had been met with raucous cheers. “I was excited but I was also worried,” Pianalto said. “I started to wonder, ‘Why are employees so excited for me? What are they expecting?’ When I asked several employees, I got the same answer, ‘We expect that you won’t change, and that you will continue to care about employees.’”

7. Check Consolidation
For decades, the single largest operation in the Federal Reserve System was check clearing. The Federal Reserve Bank of Cleveland once processed 11 million paper checks every night in the Fourth District. But as technological innovation made other forms of payment popular, Americans simply stopped writing paper checks like they used to. Starting in 2003, check operations were consolidated across the Federal Reserve System. The consolidation was painful for employees who lost their jobs. Pianalto noted that having to part with valuable employees is always the most difficult part of a CEO’s role. Throughout the consolidation, the Federal Reserve Bank of Cleveland maintained a leadership role in check processing. In 2008, the Bank’s check function was selected as the final paper check processing site and the final site for check adjustments for the entire Federal Reserve System. Pianalto observed at the time that the decision reflected the Bank’s long-term commitment to efficiency, effectiveness, and customer service. One positive outcome of the consolidation was that it led the Bank to focus not just on operational excellence, but also on thought leadership. The last paper check was processed at the Federal Reserve Bank of Cleveland on December 31, 2012.

8. Landmark Research on Education and Innovation
Early into her tenure as president and CEO of the Federal Reserve Bank of Cleveland, Pianalto challenged her staff of research economists to better understand why the Fourth District wasn’t growing as fast as most of the regions in the country. In response, they looked at the 50 states over a 75-year period. During that entire period two factors stood out as the most important for driving income growth: education and innovation. The message resonated strongly with Pianalto. She has cited that landmark 2005 study in many of her speeches over the years, and the lesson from that study continues to resonate across the region in the form of growing recognition among policymakers and elected officials about the importance of supporting education and innovation.

9. Weathering the Financial Crisis
While traveling overseas in the summer of 2007, Pianalto took a call from one of the Bank’s directors. He was worried about slowly worsening conditions in financial markets. It was one of the first hints of the crisis that would become full-blown a year later. Pianalto said later she felt humbled by the financial crisis, which prompted a realization that there were serious gaps in the Federal Reserve's field of vision. “I think it is fair to say that the Federal Reserve was too narrowly focused on banks and not the broader financial system,” she said. “The crisis taught us differently. There was a lot we didn’t know and much we couldn’t control.” That said, she took pride in the quick response and aggressive actions taken across the Federal Reserve System. At the Federal Reserve Bank of Cleveland alone, almost $100 billion was lent to institutions through its discount window during 2008. Efforts like that ultimately helped to prevent a financial market meltdown. Also, creative and aggressive monetary policies prevented a depression and helped to put the economy on a path to recovery.

10. Leading a Payments Evolution, Part Two
In 2009, Pianalto took over as chair of the Financial Services Policy Committee, the body responsible for directing payments services at the Federal Reserve Banks. Pianalto looked forward to the challenge of a world where technology was fast expanding the possibilities for all sorts of payments, and helping the Federal Reserve adapt to the new environment. The Financial Services Strategic Plan that the Committee unveiled in 2012 provided the framework for collaboration with the payments industry to further improve the speed, safety, and efficiency of modern-day payments. “To succeed in improving our nation’s payments system, we must continue to engage and find ways to leverage our collective strengths and resources,” Pianalto told an annual conference of payments industry leaders in 2013. Pianalto hands over the reins with a well-laid foundation for leading the development of the next generation of payments systems in the United States.

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Sandy Pianalto's timeline

A premier Reserve Bank and an influential voice in and for the Fourth Federal Reserve District.
Greg Stefani

Message from the First Vice President

Bold. Clear. Aspirational.

These three words describe the Federal Reserve Bank of Cleveland’s 2014−2016 Strategic Direction: a plan that will establish us as a premier Reserve Bank and an influential voice in and for the Fourth Federal Reserve District—the region we serve.

In 2013, we set out to develop a strategic direction that would capitalize on our knowledge and experience, engage us with our stakeholders, and resonate with our employees. We have built a strong hub of economic knowledge, particularly in inflation and household finance, and recognize our ability to further support the regional and national economies by increasing our focus in these fields. We have pioneered new ways to identify and analyze systemic risk, and see potential for advancing our knowledge of financial stability by integrating our supervisory and research capabilities. We have enhanced our revenue collection systems for the US Treasury with greater functionality, and continue to leverage new technologies. We have long been recognized for our operational efficiency and effectiveness, and see opportunities to become a driver of continuous improvement within the Federal Reserve System. We also know that our knowledge and experience are of little value in a vacuum, and that our success in executing our strategy hinges on how strong and relevant our voice is.

There are four key components to our plan—they are the pillars that support our mission and vision:

Voice of the Fourth District by being an influential voice in our region and a leader in the Federal Reserve System
Promote Economic Growth and Development by advancing research on key drivers of regional and national economic growth to guide policy decisions
Strengthen Financial Stability by influencing policy decisions to strengthen our nation’s financial system
Deliver Innovative Solutions by proactively identifying and developing solutions to transform our Bank and our services

Executing on a strategic plan of this magnitude requires the commitment of talented, adaptable, and engaged employees—employees who are invested in our mission and vision and connected to our strategy. I am proud of our employees and their accomplishments and sincerely believe that our people make the difference. They drive our culture of innovation and continuous improvement. They listen to and inform our stakeholders and influence policy decisions on issues important to our region and nation. They expand our presence and serve as our ambassadors. Our employees are the voice of the Fourth District—they are the Federal Reserve Bank of Cleveland.

I invite you to see for yourself their impact—how they make the difference, every day. Last year alone, we collected more than $600 billion dollars on behalf of the US Treasury for government agencies, exchanged nearly 6 billion currency notes for member depository institutions, hosted close to 10,000 education program participants, conducted more than 150 examinations of financial institutions, published impactful research on inflation, labor markets, and housing, and shared our knowledge in 150-plus speeches. You can learn more about our employees’ successes—their innovations, their expertise, their influence, and their reach—in our “By the Numbers” video below.

100 years of service

The year 2013 ended with a significant milestone for the Federal Reserve; on December 13, we began to commemorate our centennial—100 years of service to our region and our nation. As part of the commemoration, we reaffirmed our commitment to promote economic prosperity for all Americans for the next 100 years, and beyond. The Federal Reserve Bank of Cleveland is excited to have begun work in 2014 that will help us both fulfill our commitment and reach our vision of being a premier Reserve Bank. We look forward with great anticipation to the remainder of 2014 and to the years ahead.

Appreciation for a leader

In closing, on behalf of our employees and our Boards of Directors, I extend our sincere appreciation to Federal Reserve Bank of Cleveland President and Chief Executive Officer Sandra Pianalto. Sandy is scheduled to retire at the end of May 2014. It was under her leadership that the Cleveland Fed strengthened our policy focus and broadened our expertise to become more of a knowledge-based organization. It was also by following her vision that we developed our bold, new strategic direction.

On a more personal note, Sandy and I have both spent more than three decades here at the Cleveland Fed, and I’ve been especially privileged as first vice president to work alongside her for the past three years. She has not only been my trusted colleague, but also an advisor, a confidante, and a coach. All of us affiliated with the Federal Reserve Bank of Cleveland are forever grateful for Sandy’s leadership and friendship, and we wish her the best in her future pursuits.

Gregory L. Stefani
First Vice President and Chief Operating Officer

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Copyright 2014 / Financials / Inflation Central / Federal Reserve Bank of Cleveland / All rights reserved.