Bullard makes sense, but misses the vital “ingredient”

In “The St. Louis Fed’s New Characterization of the Outlook for the U.S. Economy”, Bullard states:

It is a good time to consider a regime-based conception of medium- and longer-term macroeconomic outcomes. Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon.

Any further cyclical adjustment going forward is likely to be relatively minor. We therefore think of the current values for real output growth, the unemployment rate, and inflation as being close to the mean outcome of the “current regime.”

Of course, the situation can and will change in the future, but exactly how is difficult to predict. Therefore, the best that we can do today is to forecast that the current regime will persist and set policy appropriately for this regime. If there is a switch to a new regime in the future, then that will likely affect all variables—including the policy rate—but such a switch is not forecastable.

What´s missing is the acknowledgement that the “current (or any) regime” is the result of Fed decisions. In that case, if “further cyclical adjustment going forward is likely to be relatively minor” is mostly because the Fed is perfectly happy with the current regime.

The panel below “defines” three “regimes”: The “Great Moderation” regime, the “Great Recession” regime and the “Depression” regime. While Bullard (who changes views much more often than the other FOMC members) is content with the “Depression” regime, many of the others, by constantly talking “rate hikes”, are fliting with a change to a “Deeper Depression” regime!

Bullard States

In level terms:

Bullard States_1

Update: Ryan Avent agrees:

If the global real interest rate is in the neighbourhood of 0% and expected inflation is in the neighbourhood of 1%, that suggests the Fed will have an extremely difficult time raising nominal interest rates beyond 1%. Mr Bullard has the regime right, but the causation wrong. The Fed has driven the economy into this rut in its determination to keep inflation low.

2 thoughts on “Bullard makes sense, but misses the vital “ingredient”

  1. “Bullard makes sense”. Dangerous talk. Even if maybe this current version of Bullard seems good, there is no guarantee the next version will be good. Still, credit where credit is due.

  2. I wonder why Bullard doesn’t want to escape this regime? They could lower IOR back to zero. Then, once inflation (sadly, they won’t look at NGDP) hits 2.1%, they could start selling down their balance sheet as velocity returns to normal.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s