Last Friday, Fed Governor Lael Brainard addressed trainees attending the 20th annual summer program intended to advance diversity in the economics profession, a demanding and often lonesome trail. The program takes place at Michigan State U in East Lansing, and is sponsored by the American Economic Association and the National Science Foundation.

Brainard notes that, “Between 1995 and 2014, the share of women obtaining a doctorate in economics held roughly steady in the neighborhood of 30 percent. Among U.S. citizens and permanent residents earning doctorates, the representation of those identifying as black, Hispanic, or Native American among the pool of doctorate recipients improved from 6 percent in 1995 to 11 percent in 2007. But the improvement has since unwound and the underrepresented minority share stood at about 7 percent in 2014.” [This is at odds with progress in the other STEM professions.]

The idea that broadening diversity and opportunity is the right thing to do sometimes obscures the truth that it is best practice. As Brainard put it, “The quality of the economics profession and its contributions to society will be stronger when a broader range of people are engaged…. We now have substantial empirical evidence documenting the benefits of diversity in broadening the range of ideas and perspectives that are brought to bear on solving problems.”

If you’re a hard-nosed pragmatist interested only in results, perhaps you already knew this.

Here’s some of that evidence, accessed through Brainard’s footnotes, as well as some possible reasons and suggestions.

“Ethnic diversity deflates price bubbles,” tested the authors’ conjecture that bubbles can be thwarted by ethnic diversity. Looking at markets in Singapore and in Texas, they found that traders in homogenous markets are more likely to accept speculative prices, their errors are more tightly correlated, and when the markets crash they do so with a bigger bang than more diverse markets, where prices fit true value 58% more accurately.

A McKinsey study found that companies ranked in the top quarter by ethnic and racial diversity are 35% more likely to beat national industry means in financial returns, and companies ranked in the top quarter by gender diversity 15% more likely to do so. Companies in the bottom quarter are less likely than the average to produce above average returns, and therefore are not just not leading, they are dragging. This unequal performance suggests that diversity is a competitive differentiator.

And Credit Suisse reports that large-cap companies with at least one woman on the board have outperformed their peers who have no women on the board by 26% in the 6 years leading into 2012. That’s a bit of an old study. Perhaps it’s no longer true that there are large-caps that have no women on their boards.

And, the last word in stark…

Another Personality and Social Psychology study involved 3-person teams taken from the same fraternity or sorority house and tasked with solving a murder. Each “detective” worked independently to identify the most likely suspect and then joined up to provide a collective answer. A few minutes into the discussion the Greek groups were joined either by another member of their house or by an outsider. After turning in their answers, the more diverse groups thought their interactions were less effective than the homogenous teams, and were less confident in their conclusions.

But they were “starkly” wrong. The addition of an outsider doubled the teams’ chances of getting the correct answer, from 29% to 60%.

Tough is good

David Rock, Heidi Grant and Jacqui Grey, who wrote the HBR mentioned directly above, believe that working with people who are different from ourselves challenges our brains to overcome our “stale ways of thinking.”

The discomfort that caused the more diverse teams to feel less confident when they should have been more is the point: such difficulty improves the outcome and sharpens thinking. The authors cite a study carried out in mock juries where white jurors processed the facts of the case more carefully when blacks were added to the juries. So…

Why so slow?

In their, “Diversity in the Economics Profession: A New Attack on an Old Problem.” Amanda Bayer, Professor of Economics at Swarthmore, and Cecilia Rouse, Dean of the Wilson School of Public and International Affairs at Princeton, quickly get to some possible reasons for our lack of success in diversifying the economics profession, spotlighting evidence that “may be less familiar to economists,” than the problem itself.

Although many hypotheses advance math prep, instructor race/gender, past experience in economics as the culprits, it is hard to get to a conclusion. One team looked at a dataset for 11 large state universities and found that an array of variables, including aptitude, do not explain the disparity in going beyond that first intro economics course.

(We have an anecdote here. Coincidentally, one of us spoke with a college sophomore the other day. She had taken one economics course and passed on the second: the tenets that were taught did not fit with her own experience, and when she, therefore, questioned their validity, the professor’s answers did not convince her. She’s a chemistry/physics major, so it’s unlikely it was an aptitude issue. The conversation at the table was about economic issues, and she kept up with the grown-ups handily, but after that one class she had lost interest in the academic side.)

Other STEM fields are far more diverse: One study that found “no significant sex differences” in promotion of professors in fields with heavy math requirements, labeled economics an “outlier with a persistent sex gap that can’t be explained by productivity differences.” And, in 2014, women earned 43% of degrees in math and statistics, well above that 30% in economics.

Although implicit bias research has not been targeted to economics, the authors cite a study of economics professors up for tenure at the 30-top universities between 1975 and 2014. The study showed that while an additional co-authored paper has the same effect on a man’s chances of attaining tenure as does a paper he published on his own, women are penalized for co-authoring, especially if the co-author is male.

As an example of how deep such bias runs they note that in the business sector, a serious offender, identical research queries were sent under names designed to telegraph that the sender was Caucasian, African-American, Hispanic, Indian or Chinese. Eighty-seven percent of the “white” males received responses; only 62% of the others heard back. It seems unlikely that economics is not similarly plagued.

Let’s move on to some of the less-known possibilities. One unintended effect might be that economists generally don’t put together programs that would make the field more inclusive to under-represented populations. Bayer and Rouse wonder how much we can trust economists, who so often frame choices as “individual objective decision-making,” to police themselves for discrimination? In one role-playing experiment, men who thought of themselves as “objective and logical” were more likely to favor male applicants.

And it probably doesn’t help that salaries of female full-professors fell from 95% of those of males in 1995 to 75% in 2010.

Creative destruction to the rescue

Bayer and Rouse advance some concrete approaches. First and foremost they believe we need to revise how economics is taught. In recent years, the lecture has repeatedly been shown to be “inferior” to other teaching strategies, and yet it remains dominant.

Bayer and Rouse suggest professors adopt an ask rather than tell approach. This won’t bog down intro courses as students can use clickers to respond to questions quickly. Also, we could use more in-class experiments and labs, again rather than relying on lectures. Such active learning is all good in terms of higher scores and lower failure rates. And maybe those more diverse teams could come up with some better answers to those old economic questions we’re grappling with these days.

On the draw side, there’s attention to recruitment and mentoring programs, and abatement of bias and discrimination. Small changes can do a lot in things: balancing the number of women and minorities shown in class materials reduces stereotype threat. The Harvard study stresses that it’s better to be direct: acknowledging that differences exist and diversity is valued is far more effective than those somewhat humorous mock-ups that show one of every known stereotype beaming in unison. It’s also a good idea to wait a few seconds after asking a question so that the first students to raise their hands are not always the ones to answer questions. That way the more reticent students also have the important experience of public speaking.

Other small things include listening, encouraging, and giving credit to others for their ideas. What a concept.

Perhaps that’s something The Maestro might have thought he could do, but the members of the Federal Reserve are showing considerably more humility these days. When you read their words, it seems they are by and large trying to do their work, and in a stretch when possibilities formerly known as curiosities, like the Zero Lower Bound, hopped out of theoretical research papers and onto their plates.

In a recent interview, David Beckworth asked St. Louis Federal Reserve Bank President James Bullard if, could they start all over again, members of the FOMC might consider nominal GDP or price level targeting instead of the current dual mandate of stable prices and hard-to-define full employment, Bullard’s careful response was, “I think…from just a theory basis, I think there is more sympathy than there would have been a few years ago,” and added we aren’t there yet. He himself is more sympathetic than he once was.

Inflation? Follow the Trend…

Bullard brought up the question–what drives inflation?—as a key issue today, noting that, “…the answer you get from various angles is always the same: that inflation doesn’t seem to be related to the variables that we think it should be related to.” Although he advances inflation expectations as one of the stronger contenders, even that isn’t particularly well correlated with inflation. (He also likes the idea that the central bank target moderates expectations, while the bank drives the ‘flation car.)

The Phillips Curve seems to have lost its swag, Bullard maintains it never had much, and the (unorthodox and troubled) fiscal theory of the price level—that prices are determined by government debt and fiscal policy, with monetary policy playing a muted second fiddle—“leads to a lot of confusion about what is being said.”

A funny thing about the Phillips Curve: it’s been roundly questioned since it was knee high to a grasshopper. Just six years after A.W. Phillips laid it out, Milton Friedman and fellow monetarists pointed out various issues. To Friedman, it had a basic defect, the inability to distinguish between nominal and real wages, and held only in the short-run and when inflation and expectations were steady. The economics of the coming decades further tarnished the curve’s reputation.

A bit simplistic but, of course, if the Phillips Curve were truly robust, there would be no such thing as stagflation; we’d be in a naturally correcting environment. Yet in the 1970s unemployment increased along with inflation, and in the 1990s unemployment and inflation fell together. The many other economic factors that affect pricing, including tight competition, supply shocks, a greater central bank presence, and changes in the make-up of the labor market, over-power the logical connection between low unemployment and inflation.

“Deflating inflation expectations,” a recent study by Stephen Cecchetti, Michael Feroli, Peter Hooper, Anil Kashyap and Kermit Schoenholtz, suggests we should pay less attention to expectations and slack and focus instead on trend. They argue that while inflation expectations do correlate with the trend, it’s a misleading relationship because as inflation moves, expectations move with it. They point out that if inflation is moving at 2%, most will expect it will continue to do so, and will be right. They suggest instead we compare the change in inflation expectations to the change in inflation. That doesn’t work so well: changes in inflation expectations “tell us nothing” about changes in inflation.

Since inflation is currently a bit below the Fed’s target, and long-term inflation closely follows the past few years’ average, they suggest the Fed will likely need to allow a short, modest overshoot to get us to 2%.

But Bullard also points out that in 2012, when headline and core inflation were right on target, he thought the Fed’s “work was done,” but then inflation began to slip, which he has noted was happening again in the spring. That overshoot may prove elusive.

…and get rid of Core PCE

Bullard suggests the core measure of PCE should be “thrown out.” First, he is not willing to go back to his constituents and say, “We stabilized prices, just not the ones you have to pay the most often.” Second, one of his colleagues looked into food prices and found that for some stretches they are the least volatile of all components. Bullard called it “kind of comical” that we’re throwing them out because they were so volatile in the 1970s. Third, core inflation “sunk a bit, maybe a couple of tenths on a y/y basis,” when energy prices fell in the 2014, and have since reversed course. That’s because there are core components that are heavily affected by movements in energy prices, so the effect is still in there.

Bullard favors the Dallas Fed’s trimmed mean measure, running at 1.5% in May, but since so many models were built on core prices, he doesn’t think there is much will to recalibrate them all. We’d say this is not a good reason not to work to improve such an important measure, but it may be an overwhelming one. Perhaps that argues for nominal GDP, which washes out any issues with how inflation is forecast and tracked.

Interpretations of Fed Governor Lael Brainard’s speech on Tuesday, May 30th, to the New York Association of Business Economists were wide ranging: some thought she has shed her dovish feathers, others that she is signaling uncertainty at the FOMC concerning the direction of monetary policy. We read her talk as a continuation of her focus on ongoing weakness in inflation despite, as she put it, the growing number of forecasters who believe the U.S. economy is at or very close to full employment. We’d like to look beyond the immediate implications for monetary policy in her talk and highlight some underlying premises. Part of that is admittedly because we think she is making important points but, hey, with rates heading up we will need to shift the conversation to the issues beyond the reach of interest rates. The sooner the better.

In her opening remarks she notes that we are currently seeing a synchronized expansion, which has moved global risks in a positive direction, and forecasts are moving up, which has broken a string of downward revisions. She is encouraged that the U.S. Labor Force Participation Rate has held steady even while facing, “what many believe to be a downward trend in demographics”; the employment/population ratio is at a post-recession high, and those working part-time against their wills is close to its pre-crisis level. The U-3 employment rate, the “official” rate, is now at its 2006/7 cyclical low, although she notes that the rate was at and below that level in the late 1990s.

If all continues to go as preliminary data for the second quarter suggest, the federal funds rate will be well on its way to neutral and the FOMC will turn its attention to the balance sheet soon. But.

Brainard quickly moves to the “tension” between the signs that we are reaching full employment, and the possibility that “tentative progress on inflation…may be slowing.” If progress on employment and the lack thereof on inflation persist, she will reassess the path currently outlined for both the funds rate and the balance sheet.

One concern is the unemployment rate, but not quite what you’d guess. What worries her is that in the past when the unemployment rate has been as low as it is currently, it has been hard for expansions to sustain themselves. With very little growth in the labor force, it’s hard to keep GDP moving. And, we’d add, even without law changes, a bellicose attitude toward immigrants could flatten what growth we are seeing, and even cause a contraction—or at least severe distress in industries like construction, restaurants, and even tech.

Brainard notes that in the past rising inflation has sounded the “death knell” for expansions, but that inflation expectations have been stable in the most recent expansions. From 1998 into 2001 core PCE inflation never exceeded 2% on a four-quarter basis, and the high of 2.4% in 2006/7 was a pass-through in import prices—in other words not a child of durable wage inflation.

She also notes the Atlanta Fed’s Wage Growth tracker showed upward movement in wages until about a year ago, but has shown little acceleration recently, the Employment Cost Index is up from a year ago, but down from two years ago, and boring old average hourly earnings are moving at the same pace they were last year. Core consumer price inflation (national accounts basis) was up just 1.5% on a twelve-month basis in the April report, well below the FOMC’s 2.0% objective, and although the most recent reports may have been depressed by upgrades to cell-phone plans, the distance to the goal is a “cause for concern.”

Take that, Phillips Curve

Calling the Phillips Curve a “less reliable guidepost” than it once was, Brainard turns to inflation expectations from the Michigan Consumer Confidence survey, which remain near their all-time low, although the New York Fed’s measure of three-year inflation expectations rose to its highest level in more than a year. Market-based measures of inflation compensation have improved, but remain below the average that ran between 2010 and 2014. She sees more signs of a slowing in inflation than an upside break, which she thinks may be the result of the non-linearity of inflation and unemployment when unemployment is so low. The flatness in the Phillips Curve is also apparent in European economies.

Brainard wonders if NAIRU is currently lower than it was, which makes sense to us, or if perhaps the U-3 is overstating the strength of the labor market. The employment/population ratio for prime age workers remains 1 point below its pre-recession level. She didn’t mention the quit rate, which is improving slowly but remains soft in many sectors by long-term standards, which we detailed recently and would argue has a lot to do with weakness in wage growth.

We put together an estimate of the quit rate between 1967 and 2000 using job leavers and short-term unemployment (the quit rate tracks those unemployed for less than 5 weeks very closely), and then switch to the Job Openings and Labor Turnover Survey’s measure, which began in 2000. Using the longer run quit rate, the current rate would be historically consistent with an unemployment rate of 6.3%; using the JOLTS period only, 5.1% Back in 2014 the quit rate was implying an unemployment rate of 7.7% instead of the 6.7% it actually was, so it’s a long standing disparity.

The wage piece of the U.S. labor market is having a tough time getting off the mat; if you put theory and ideology aside and listen to what people are saying, worker insecurity is a big deal these days, and compensation packages are far from what they once were. The Beige Book reported that employers are lifting wages to attract employees, but we don’t think that will overpower the long-term degeneration in wage structures that has occurred since the financial crisis.

Brainard didn’t change anything on her favored approach to reduction of the balance sheet, subordinated to changes in the funds rate—predictability rules at the Fed these days—and she reiterated that the balance sheet itself would come into play should the economy experience adverse surprises during the normalization process.

Revenues at the state level continue to do OK, if running below past performance. We believe that that relative weakness is itself another measure of the divergence between growth and prices evident in many data series, and Governor Brainard’s focus.