The Fed insists in hanging on to a wrong model

As the R-Day (that´s rate rising date) approaches, we read in The Mystery of Missing Inflation Weighs on Fed Rate Move that:

Federal Reserve officials this week are expected to raise interest rates for the first time in nine years on the expectation that employment and inflation will hit targets reflecting a healthy U.S. economy.

But Fed officials face a troubling question: Jobs are on track, but inflation isn’t behaving as predicted and they don’t know why. Unemployment has fallen to 5%, a figure close to estimates of full employment, while inflation remains stuck at less than 1%, well below the Fed’s 2% target.

Central bank officials predict inflation will approach their target in 2016. The trouble is they have made the same prediction for the past four years. If the Fed is again fooled, it may find it raised rates too soon, risking recession.

Why don´t they let go of their misleading model, instead of hanging on?

According to former Fed staffer Jon Faust:

“We thought we figured out macro policy, and we could deliver low, stable inflation and stable output and low unemployment and all things good.”

The financial crisis deflated that confidence. Confronted by low inflation and sluggish economic growth, the U.S. and U.K. nearly seven years ago—and the eurozone three years later—slashed interest rates to near zero.

But they got low stable inflation, stable output and (now also) low unemployment. Why, then, aren´t they happy?

The problem is that the LEVEL of inflation and real output stability is too low! And, as the charts show, that´s because the LEVEL of NGDP growth, although also stable, is nevertheless too low to provide an inflation rate closer to target and a more robust real output growth (and a more convincing low rate of unemployment that is not so dependent on low rates of labor force participation).

Hanging on

Let´s Hang on (to what we´ve got)

One thought on “The Fed insists in hanging on to a wrong model

  1. Pingback: Brexit-Like Political Shocks Are Mere Noise, Central Banks Are The Only Real Shockers | The Corner

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