The Fed, by tightening, is reducing “slack”!

Speaking at a conference in Beijing, Boston Fed President Eric Rosengren said it has been appropriate to be patient about normalizing interest rates, given that growth “has continued to underwhelm.” But the Fed’s mandated goals – stable prices and maximum sustainable employment – are likely to be achieved relatively soon, and “keeping interest rates low for a long time is not without risks.”

As a result, important questions confront monetary policymakers in the United States, including when and how quickly to continue normalizing interest rates.

Why are they so worried if inflation, as measured by the PCE-Core has remained below the 2% target level for almost the whole time since end-2008, even if “full employment” is all around us?


What they don´t realize is that “slack” has been diminishing because they are keeping the economy ever more subdued. The idea of “potential” is risible because actual NGDP seems to be the strongest determinant of “potential” NGDP.

In the chart you can see that while for the years prior to 2013 potential NGDP in the latest vintage (August 2016) was revised slightly up, compared to the 2011 vintage (the earliest available in Alfred), for the past two years it was revised down significantly.



Now, note that´s exactly the period during which NGDP growth has tumbled down, the outcome of all the tightening talk going on at the FOMC!


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