While the Fed goes “star trekking”, nominal stability is forsaken. As Bernanke argues, the FOMC´s forecast of the “star variables” – y*, u*, and r* – which, respectively, denote potential real output, natural rate of unemployment and the neutral interest rate, variables over which the Fed has no control, have been systematically downgraded. His table illustrates:
And Bernanke concludes:
FOMC communications also have been affected by the recent revisions in the Fed’s thinking. It has not been lost on Fed policymakers that the world looks significantly different in some ways than they thought just a few years ago, and that the degree of uncertainty about how the economy and policy will evolve may now be unusually high. Fed communications have therefore taken on a more agnostic tone recently. For example, President Bullard of the St. Louis Fed has recently proposed a framework which implies that, in most circumstances, economic forecasters can do no better than to assume that tomorrow’s economy will look like today’s. Other participants, noting earlier failures of forecasting, have argued that (for example) policy should not react until inflation has actually risen in a sustainable way, as opposed to being only forecast to rise. In general, with policymakers sounding more agnostic and increasingly disinclined to provide clear guidance, Fed-watchers will see less benefit in parsing statements and speeches and more from paying close attention to the incoming data.
To argue that you should all but ignore the Fed is certainly very confusing!
Meanwhile, the people at Gavekal are on the right track when they write:
We were fortunate enough to have Nancy Lazar, from Cornerstone Macro, in our office today and she emphasized a very important point: nominal GDP is ultimately what really matters.
Nominal growth is what drives corporate revenue, and in turn, drives business spending. Because businesses are the backbone of any economy, trends in nominal GDP greatly impact inflation, wage growth, consumer spending, capex and interest rates to name just a few macro economic variables.
When the first release of 2Q GDP came out in late July, we noted how the 10-year annualized change in GDP had fallen to just 2.94%, which is the lowest growth rate on record going back to 1957. In the subsequent charts below we see how this structural decline in nominal GDP is reverberating through other parts of the economy.
There´s a better way to see the importance of nominal stability – the appropriate level and growth rate of nominal GDP (NGDP). In the panel below, which charts NGDP growth at time t against growth at time t+1, we see that what came to be called “Great Moderation”, characterized by stable real growth and stable and low inflation, was a period in which NGDP growth was stable and evolving along a stable trend level path.
During the “Great Inflation” we see that NGDP growth was excessive and upward trending. At present (“Great Stagnation”), after trending down, NGDP growth has once again come back into the “stability circle”. However, NGDP growth is “too low” and is evolving along a trend path that is also too low. In fact, as the chart below indicates, it appears that since 2014 NGDP growth is even veering off from this lower path.
No surprise, then, that “Fed communications have taken on a more agnostic tone”. As Bernanke argues: “It has not been lost on Fed policymakers that the world looks significantly different in some ways than they thought just a few years ago.” And what´s different is of Bernanke´s own making when, as Fed Chairman, he let NGDP (something which the Fed can closely control, in contrast to the “star variables”) drop significantly. But since they don´t know “what´s different”, stay tuned for more Fed mistakes going forward!