A James Alexander post
The last blog post was a great analysis of the last thirty years of US monetary policy as the Fed focused on Core PCE inflation and unemployment and for most of the time accidentally got NGDP growing on target. When the Fed switched rigidly to focusing on its own projections for Core PCE things started to go awry, both with unemployment and NGDP.
Still focusing on those projections since 2009 it has got things right in fits and starts only. Unemployment has ever so gradually returned to 5%, a record slow recovery. That said, there is still tons of labor market slack as evidenced by the participation ratios, ultra-low nominal wage growth and low quit rates. These factors mean there is very little productivity growth as the labor market is so lacking in energy. Core PCE keeps missing Fed projections of a return to 2%.
This troubled but not yet terrible situation is summed up by, actually caused by, the dreadful growth rate and level of NGDP.
So why does the Fed want to raise rates?
Trying to put myself in the mind of the average FOMC member I came up with this “logic”, although it is not logical – perhaps because it reflects so many competing views and not just one human brain:
1. The Fed wants to raise rates to give it the room to cut them when the data goes bad – even though we know the data will go bad due to the raising of rates, or the constant threat of raising rates.
2. The Fed is thus stuck as it really doesn’t want to:
a. use negative rates because the banks, insurance companies, money market mutual funds and savers will complain very loudly;
b. do more/wider QE because too many politicians, internet Austrians/goldbugs, alt-right, progressives, socialists, etc. will all complain about the Fed creating winners and losers “and may require legislation” as Yellen said;
c. do helicopter money, defined here as directly new-money financed fiscal expenditure as it is bound to run up against any unaltered Core PCE inflation target projections
3. While the Fed needs rate-cutting firepower it is unlikely to have been able to raise before the data goes really bad
4. So the Fed has to look at more innovative alternatives than negative rates or more/wider QE. Thus it is tentatively looking at a higher inflation target or even level targets for inflation or nominal growth, instead as a sort of last resort back-up plan.
The Fed is causing this confusion because the logic is confused. It has the wrong targets and they are both causing and storing up trouble. Changing the targets would be the right thing to do, even if for all the wrong reasons.
Using market rates to forecast the 10 year bond rate and the dot plot to project the Fed funds rate, the FOMC members are expecting to invert the yield curve in 12 to 18 months or so.
it’s almost what they seem to want, weirdly … Fischer epitomises the attitude, calling growth “mediocre” one, wanting to raise rates the next …