In the last year or two we've seen a lot of improvement in jobs and employment, and economists were confounded by it because inflation didn't accelerate. And now they talk about how the Phillips Curve is "broken". They refuse to consider the possibility that the kind of good economy we had in the latter 1990s could return.
Tim Duy at Economist's View, quoting Cleveland Federal Reserve President Loretta Mester:
... my current assessment is that inflation will remain below our goal for somewhat longer but that the conditions remain in place for inflation to gradually return over the next year or so to our symmetric goal of 2 percent on a sustained basis. These conditions include growth that’s expected to be at or slightly above trend ...
... the 70 percent confidence range for forecasts of PCE inflation one year ahead is plus or minus 1 percentage point, and a significant portion of the variation in inflation rates comes from idiosyncratic factors that can’t be forecasted. Indeed...
FORECASTED.
...forecasted. Indeed, since the 1990s, assuming that inflation will return to 2 percent over the next one to two years has been one of the most accurate forecasts.
Tim Duy responds:
Since 1990, a 2 percent forecast has worked more than not, so lets just stick with that as the baseline for policy? By that logic, since the great recession, a 1.75% forecast has worked more than not, a testament to the Fed's one-sided inflation target and falling inflation expectations. I am not buying into her inflation forecast story yet.
He's a pretty good read.
As Duy points out, the more recent inflation numbers have been lower. Thinking in terms of averages, if the average since 1990 is 2% and the average since 2009 is 1.75%, then the average for 1990-2009 must be higher than 2%. Thinking in terms of year-on-year results, this appears to be the case:
 |
| Graph #1: Core PCE Inflation (the Fed's measure of choice) since 1990 |
Looking at that graph, I just want to remind you that the latter 1990s were pretty good for employment and income and real GDP growth, not just for price stability. Economists consider that a fluke, though. They refuse to consider that it could happen again. In the last year or two we've seen a lot of improvement in jobs and employment, and economists were confounded by it because inflation didn't pick up as well. And now they talk about how the Phillips Curve is "broken". But they refuse to consider the possibility that the kind of good economy we had in the latter 1990s could come back.
Duy quotes New York Federal Reserve President William Dudley:
Overall, the economy remains on a trajectory of slightly above-trend growth, which is gradually tightening the U.S. labor market. Over time, this should support a rise in wage growth. When combined with [other] factors, that causes me to expect inflation will rise ...
See? Dudley cannot imagine that inflation will remain calm as the economy improves -- broken Phillips Curve or not. A repeat of the latter 1990s is inconceivable to him.
(President Dudley says he expects inflation to rise just to the Fed's target and stop there (at 2%) but doesn't say why. Not by natural causes, certainly. By aggressive rate hikes, should inflation attempt to exceed its target. Typical Fedspeak. Dudley isn't predicting inflation. He's threatening to act against it.)
Duy further quotes William Dudley:
But, the upward trajectory of the policy rate path should continue to be shallow, in part because the level of short-term interest rates consistent with keeping the economy on a sustainable long-run growth path is likely to be considerably lower than it was in prior business cycles.
NO COMMA AFTER "BUT"
Duy quotes more:
If it turns out that structural changes have played a significant role, I would generally view this as a positive, rather than negative, development. It would imply that the U.S. economy could operate at a higher level of labor resource utilization without generating a troublesome large rise in inflation. More people could be put to work on a sustainable basis, enabling them to gain opportunities not just to earn greater income, but also to develop their skills and grow their human capital.
And Duy says this suggests
a downward revision of estimates of the natural rate of unemployment.
Tim Duy is right.
Notice that Dudley mentions "structural changes" (but fails to identify the changes or their causes), says it's a good thing (ooh, ooh, maybe he can imagine that inflation will remain calm as the economy improves! Nah, it's probably just words). And the rest of the paragraph just gets giddy. Rather than explaining the fall of the natural rate of unemployment, he gives us the happy ending.
Duy again:
Separately, on the data front, we get this from Commerce, via Reuters:
The U.S. economy probably grew faster than reported in the second quarter, with data on Thursday suggesting stronger consumer spending than previously estimated.
The quarterly services survey, or QSS, from the Commerce Department implied consumer spending increased more briskly than the 3.3 percent annualized rate reported last week in its second estimate of gross domestic product.
The Fed forecasts are based on more modest growth numbers. Stronger growth numbers will tilt them toward further rate hikes.
Yup: If growth improves, policymakers expect inflation. They simply refuse to consider the possibility that the economy might actually be good for a few years.
Nobody remembers the Alan Greenspan of 1995, talking about anecdotal evidence and refusing to raise rates as the economy improved.
4 comments:
"Nobody remembers the Alan Greenspan of 1995, talking about anecdotal evidence and refusing to raise rates as the economy improved."
A look at the data for the period around 1995 reveals that the Fed rate simply followed the market rates.
https://fred.stlouisfed.org/graph/fredgraph.png?g=f0uD
Notice how when rates are going up the Fed rate was below the market rate and when rates are going down the Fed was above market rates. The Fed rate was consistently 1 to 3 months behind. The evidence is overwhelming that the Fed rate was doing nothing more than following the market rates.
Yeah Jim, I can see some of that in interest rate graphs. Still, if the Fed was lower than the market on the upswing, it was helping to slow the increase of rates. And if the Fed was higher than the market on the downswing, it was helping to slow the decline of rates. That's not "doing nothing".
I brought up Greenspan and "anecdotal evidence" because it is memorable and because, whatever the reason, the policy rate stopped going up in early 1995. It was big in the news at the time. For the next few years the economy boomed, and inflation remained tame. Then, as now, the Phillips Curve was "broken".
Now, as then, we may soon have a few years of booming economy while inflation remains tame.
The Fed, as the agent we hold responsible for inflation, may be more inclined to raise rates than the markets. Investors, focused on improving their return, may be more inclined to trust the "brokenness" of the Phillips Curve and to get their returns from growth rather than from rising rates.
Tim Duy, in the last paragraph of his article, says "Markets participants are not seeing the same story as most central bankers. Something's gotta give."
I can see some of that in interest rate graphs. Still, if the Fed was lower than the market on the upswing, it was helping to slow the increase of rates. And if the Fed was higher than the market on the downswing, it was helping to slow the decline of rates. That's not "doing nothing".
It would be doing the opposite of what the conventional story says the Fed is doing, which is controlling interest and employment by driving the market interest rates up or down.
At least your story isn't contradicted by the evidence.
I have said this before, I agree with your prediction in regards to a booming economy. The evidence you presented in support of that prediction is convincing.
Thanks Jim. That means a lot.
I re-read my post. I focus way too much on Greenspan. Oh, well. The only thing I need from him is to show that maybe what's going on is more like growth than inflation. Also his timing, just before the 1990s boom.
Post a Comment