The SOMC speaks!

The Shadow Open Market Committee met and said:

The economy is growing, labor markets have improved dramatically, and inflation is forecast to return to two percent over the intermediate term. However, the Fed still expresses extreme caution about normalizing monetary policy, citing myriad concerns, ranging from sluggish wage growth and low inflation to foreign economic and political risks, which might delay the date at which interest rates finally lift off their zero lower bound. This creates the potential for an erosion of the FOMC’s credibility and suggests the Fed lacks a clear strategy for getting monetary policy back on track.

Departing from the consensus that prevailed throughout the Volcker and Greenspan Fed Chairmanships, which held that a commitment to low and stable inflation is the best contribution that monetary policy can make to sustained economic growth, FOMC officials in recent years have relied on a shifting array of ad hoc labor market indicators to guide their policy actions. Not surprisingly, these labor market measures have proven unreliable and unpredictable, and have led the Fed through a series of awkward policy target changes that have added uncertainty and reduced the credibility of FOMC members’ interest rate forecasts.

So:

Within such a rules-based system, several very specific points of guidance for monetary policymakers become clear. First, historical experience tells us that whenever interest rates are too low for too long, financial markets become distorted and inflation begins to rise. After an extended period of exceptionally low policy rates, three rounds of quantitative easing that have substantially expanded the Fed’s balance sheet, and four full years of robust M2 growth, there is already enough stimulus flowing through the economy to lift inflation back to the Fed’s two percent long-run target. In light of the present size of the Fed’s balance sheet, interest rate increases without further delay are necessary to avoid an even more costly overshooting of that inflation target down the road.

It´s very true that Fed credibility has been “shot to pieces”. But the rest of the argument is far off the mark:

Inflation instead of rising has been falling (and that long precedes the more recent fall in oil prices). The cost of an eventual overshooting in inflation are much lower than the costs of further restraining the economy to avoid that unlikely “accident”.

SOMC_1

Money growth, more adequately measured by Divisia broad money (M4) has, if anything, grown very slowly over the past four years (2.7% on average)

SOMC_2

Interest rate increases without further delay would only make a bad situation worse.

One thought on “The SOMC speaks!

  1. The SOMC, which uses a broken clock to tell time, also re-writes the Greenspan and Volcker legacies: Volcker ended his fight on inflation when he got the CPI to around 5%. Greenspan lived with moderate inflation all through his terms.

    It is Yellen who has operated with the CPI well below 2% for her entire administration. We may yet see deflation.

    The SOMC crowd are not practicing macroeconomics; it is some sort of politics, or socio-pathology. Even if the U.S. moves to deflation, I would expect the SOMC to advocate more tightening.

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