For one, I do not think the economic expansion—now in its ninth year—is vulnerable just because it is “old.” As 3/6  BIS central bankers' speeches  we like to say, expansions don’t die of old age—they die either because monetary policy needs to be tightened appreciably to combat rising inflation, or because the economy gets hit with a large shock that overwhelms the ability of the Federal Reserve and other policymakers to stabilize it successfully. In general, with inflation below the FOMC’s long-run objective we can be cautious in how we adjust monetary policy. Similarly, I am not concerned about the recent flattening of the Treasury yield curve even though some commentators believe that such a flattening foreshadows a recession. At the end of 2017, the spread between the 10-year Treasury bond and 2-year Treasury note had narrowed to 52 basis points, from 125 basis points at the start of the year. As I see it, some flattening in the yield curve should be expected as we gradually remove monetary policy accommodation. If the yield curve were not flattening, it would suggest that we were behind the curve in removing accommodation. Moreover, this recent flattening is not particularly pronounced. For example, the 10-year/2-year spread of 52 basis points is only 46 basis points narrower than the average since 1978. In addition, all else equal, we should expect the yield curve to be flatter than normal in the current environment.
One area I might be slightly—but not particularly—worried about is financial market asset valuations, which I would characterize as elevated. While valuations are noteworthy, I am less concerned than I might be otherwise because the economy’s performance and outlook seem consistent with what we see in financial markets. Volatility in the real economy has been low, and this has been matched by low volatility in financial markets, which has helped support high valuations. I am also less worried because the financial system today is much more resilient and robust than it was a decade ago. Thus, even if financial asset prices were to decline significantly—which presumably would occur if the economic outlook were to deteriorate—I don’t think such declines would have the destructive impact we saw a decade ago. Higher capital and liquidity requirements for major banks have made the banking system more resilient and better able to absorb market shocks without this impairing its ability to intermediate credit flows between borrowers and savers. It was the collapse of confidence in the financial system in 2008 that caused credit availability to dry up, contributing greatly to the severity of the Great Recession.7 So, what am I worried about? Two macroeconomic concerns warrant mention. The first is the risk of economic overheating. Now, this seems like an odd issue to focus on when inflation is low, but it strikes me that this is a real risk over the next few years.