When will the Fed recognize its failures?

Everybody and the Pope is waiting for the end of the FOMC meeting on Thursday, particularly if it will signal the time of the “feared lift-off”.

The trouble is that the Fed thinks that for the past six years it has followed an “easy” or “accommodative” monetary policy by keeping interest rates on the “floor”!

The opposite, however, is true. Monetary policy has remained tight, or even very tight, throughout this time.

What if interest rates are low because expectations of inflation and nominal spending growth are low (as Friedman reminded us long ago?). This might be so because “modern” central banking has shunned what´s going on with the money supply; and low money growth is the driving force behind today´s low interest rate, inflation and spending growth!

The charts illustrate the argument. Conservatively, I have let the initial (2008) drop in the price level (relative to trend) and the initial fall in nominal spending (NGDP) relative to trend to be bygones, forever forgotten.

Even so, the price level remains far below what it should be if the 2% target had been pursued during the recovery and the level of spending remains far below the level that would have materialized if the Fed had “cranked” a 5.5% nominal spending growth (the “Great Moderation” NGDP growth rate) after NGDP tanked in 2008.

Fed Failure_1

Fed Failure_2

Not surprisingly, both medium and long-term inflation expectations have recoiled during the recovery.

Fed Failure_3

And all this naturally follows the very low rate of broad (Divisia M4) money growth observed during the so called recovery!

Fed Failure_4

By concentrating attention on interest rates and showing “eagerness” to get them up, the Fed will instead throw the economy to the ground!

Update: The “Dot Bubble

Fed Failure_5

Human senses are wired for survival!

That´s my take from the euphoria that greeted the release of Retail Sales. This headline from the WSJ is typical: Economists See Bright Consumer Outlook:

Consumers are coming out of their shells and heading to the mall. What will keep shoppers spending for the rest of the year are much healthier labor markets, according to economists surveyed by The Wall Street Journal.

An upbeat consumer outlook was the consensus forecast of 66 economists, not all of whom answered every question. The average forecast sees inflation-adjusted household spending climbing 2.7% this quarter and more than 3% in the third and fourth quarters, much better than the 1.8% gain over the winter.

An early sign of the consumer rebound came Thursday with news that retail sales jumped 1.2% in May. Excluding autos, the gain was a solid 1%.


Of course, consumers have been fickle throughout the six-year-long economic expansion. They have spent strongly in one quarter only to retrench soon after.

But the forecasters think a high level of spending will be sustained this year because labor markets are strengthening. According to the average forecast, payrolls should increase at a monthly pace of 221,000 for the rest of the year, a notch above the 217,000 averaged in the first five months. The jobless rate is projected to fall to 5.1% by December from 5.5% in May.

But, the truth is that retail sales has done nothing more than follow aggregate nominal spending (NGDP) into a state of “semi depression”. As long as the Fed keeps AD growing at a ‘miserly’ rate, the “euphoria” is only a reflection of our survival instincts!

Wired for Survival

Krugman remains “confused” -2

Maybe because of his infatuation with the ZLB, which supposedly characterizes the quintessential “postmodern” recession:

But I do think it’s important to realize that this dispute doesn’t invalidate a related point, namely, that the kind of recovery you can expect from a recession depends on the sources of that recession. Way back — before Lehman fell! — I argued that there was a distinction between modern and postmodern recessions. Pre-Great Moderation, recessions were brought on by the Fed, which raised rates to reduce inflation, then loosened the reins, producing a V-shaped recovery. Post-Great Moderation, with inflation low and stable, booms were allowed to run their course, so that recessions came from private-sector overreach — and the Fed had a much harder time engineering recovery. This was especially true after 2007, when we hit the zero sort-of lower bound.

The recessions of 69-70, 73-5, and 81-82 were responses to inflation and the high rates the Fed imposed to fight it; the economy bounced back when the Fed was done. The recessions of 90-91, 2001, and 2007-9 were completely different.

They were different in that the Fed had acquired credibility as an inflation avoider. The 1990-91 and 2001 recessions were shorter and shallower than those that took place in 1973-75 and 1981-82.
What distinguishes the 2007-09 “Great Recession” from ALL the others is that in 2007-09 the Fed allowed nominal spending to contract at a rate not seen by most living people. And the slow recovery is, symmetrically, due to the Fed keeping nominal spending growth on a leash (maybe all this happened because with Bernanke the Fed became an inflation “paranoid”).

So you don´t need to appeal to “austerity”, the (horrible) conduct of monetary policy explains both the “deep dive” and the “slow-motion resurfacing”.

PS. PK is repeating an old argument of his. And so am I!