The Fed is holding the economy down!

The Peterson Institute for Intenational Economics has a piece titled “The Fed’s Confusion over Interest Rates“. At the end we read:

The Fed insists it wants to raise rates before the end of the year, but markets insist in not believing it, because if one uses the reaction function the Fed has always communicated there is no reason to do it. The markets have followed Bernanke’s teachings and learned the Fed’s reaction function over the years, and have concluded that, in view of the economic outlook, interest rates should not be raised until mid-2016.

If the Fed has changed its reaction function, it should explain it and openly acknowledge that there are factors beyond the inflation outlook that are affecting its decision making. Transparency is critical. If the Fed is not able to explain convincingly why it wants to start raising rates, the risk of failure will be high. The world economy is in transition and developed economies have to replace emerging markets as a source of stability.

The Fed is caught in its own inertia, as it has spent many months preparing the ground for a rate hike in the second half of this year. But the reality is that if one ignores the inertia, there is no good reason to raise rates this year. And, with rates at zero, there is little room to correct mistakes. The Fed is confused, and the cost of this confusion could be very high.

The Fed certainly is confused (and after recent talks by Lael Brainard and Daniel Tarullo, divided). It´s not a question that the costs could be very high, the costs are already rising strongly!

Since the tapering and post tapering, monetary policy is being tightened. No one would notice that from looking at the Fed Funds rate, which has remained at “zero”. Bernanke himself long ago said that to gauge the stance of monetary policy, don´t look at interest rates, look at things like NGDP growth and inflation.

The chart provides clear evidence that according to those two gauges, monetary policy is in tightening mode. The Fed´s revealed confusion only adds to uncertainty and worse outcomes. In other words, the Fed is already failing!

Fed Confused

One thought on “The Fed is holding the economy down!

  1. Janet Yellen was already somewhat cornered Ben Bernanke when he promised to taper downn. Then Yellen promised to raise rates.

    But the promises appear unconnected to economic conditions.

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