Ahead of the Fed

Here’s what the Fed needs to consider:

1.  Ben Bernanke has insisted that the Fed is not out of ammunition, and has a number of powerful tools that have yet to be deployed.

2.  In recent months, the Fed has argued that no further stimulus is needed, as the risks of the economy overheating are roughly balanced by the risks of too little AD.

3.  Both NGDP and RGDP growth have been unusually slow in recent quarters, much below levels expected during an economic recovery, and indeed below levels expected during normal times.

4.  Recent financial market indicators point to even slower NGDP and RGDP growth in the near future.

5.  The big drop in energy prices is likely to cause “headline inflation” to turn into “headline deflation” in the near future.

6.  The world economy is slowing, which reduces the Wicksellian equilibrium interest rate.  This means that the Fed’s 0.25% IOR program is effectively becoming an increasingly restrictive monetary policy.  Just yesterday the 2 year T-note yield fell below 0.25%, meaning the Fed has essentially inverted the yield curve all the way out to 2 years.

7.  Continued problems in the eurozone are putting upward pressure on the dollar.

Given these facts, should the Fed re-evaluate it’s assumption that the risks of slow growth and the risks of economic overheating are equally balanced?  I’ll be traveling today, but I hope economic pundits will let the Fed know what they think.

There’s no longer any prospect of fiscal stimulus.  There’s no longer any doubt as to who’s driving the nominal economy.  Federal Reserve officials have an important decision to make today.



27 Responses to “Ahead of the Fed”

  1. Gravatar of Gabe Gabe
    9. August 2011 at 06:51

    The Fed apologists like to pretend that the crisis created in 2008 and the crisis in 1929 were “accidents”.

    It seems that some will try to mark this crisis down as another “accident” of monetary policy in spite of the clear evidence that we are intentionally being driven into a ditch to create a big enough crisis to do what they want to get done politically.

  2. Gravatar of Gabe Gabe
    9. August 2011 at 06:53

    It is the job of knowledgeable economists here to make sure people are aware that we do not have to have a deflationary period now.

    Austrians and the NGDP targeting-school may disagree on how many problems it will solve in the long run to cause some inflation now…but IMO we are in complete agreement that the current deflation is completely avoidable.

  3. Gravatar of PJ PJ
    9. August 2011 at 07:06

    I keep thinking of this scene from Jerry Maguire:


  4. Gravatar of dwb dwb
    9. August 2011 at 07:38

    the evidence of “overheating” was primarily commodities prices and the subsequent bleed-through into core inflation as retailers and GM,ford, and others tried to raise prices – which did not work. duh, consumers retrenched. Commodities price inflation, unfortunately, is mainly being driven by the chinese 6.5% inflation rate and their refusual to let the yuan appreciate more, which would strongly stem their own inflation problem.

    The Fed has grossly overstated the risk of overheating, just as the models have consistently overstated growth, thanks to a couple hawks who keep seeing hyperinflation around the corner. The Fed needs a round of bond buying roughly the same size of the last round, but they are not that bold. They are going to wait and see the de facto recession before they act, unfortunately. Maybe they will throw the markets a bone but i would not count on it. Restructuring the portfolio to longer maturities, with treasury yields sub-3%, just wont do much – low long rates are not the problem. Charging on reserves (-.5% instead of +.25%) may help.

    and anyway… so what if we see a bout of 3% wage inflation. In the current deleveraging environment that would be a plus, and the Fed has proven time and again they are willing to hike rates to temper inflation. they have ample room to raise rates if needed! people worry about the feds inflation fighting credibility, but credibility cuts two ways, if they appear overly cautious to act.

  5. Gravatar of Gabe Gabe
    9. August 2011 at 07:49

    It wasn’t two hawks that chose to create deflation now…two votes don’t matter. It was and is Bernanke and the rest of the majority that are choosing to have a stock market and economic crash as we speak. You may not like to believe that, but this is benefitting some people and Bernanke is working for those people…not us. Keeping your head in the stand and having faith that the Fed is looking out for our best interest is childish. They don’t ccare about us, they answer to a few banksters and that is the truth.

  6. Gravatar of Benjamin Cole Benjamin Cole
    9. August 2011 at 07:49

    Please Ben Bernanke-san, please read what Scott Sumner wrote today.

  7. Gravatar of Gabe Gabe
    9. August 2011 at 08:12

    Ben Cole,

    We are random low status people that are interested in monetary policy as a hobby or as a supplement to our careers. You really think these ideas are foreign to the man who has been gifted with the power to create trillions of dollars in assets at his whim?

    He knows this stuff…he just chooses to do otherwise because he has different goals than you naively imagine. The people he really serves are happy with his performance.

  8. Gravatar of Benjamin Cole Benjamin Cole
    9. August 2011 at 08:22


    Man, I don’t know.

    Look, ideas get momentum, become accepted into the mainstream somehow. You mean to tell me we can convince people to spend $4 trillion in Iraqistan, but not to engage in a stimulative monetary policy?

    Who does Bernanke-san serve? I think he is earnest but timid. Besides, even if he were canned tomorrow he would get a cushy job on Wall Street with someone. He can do what he thinks is right–he just needs some sort of support, perhaps.

    I concede I am random low-status person, but at Least I sent a postcard to Bernanke-san. You do the same.

  9. Gravatar of JimP JimP
    9. August 2011 at 09:23


  10. Gravatar of JimP JimP
    9. August 2011 at 09:26


  11. Gravatar of JimP JimP
    9. August 2011 at 10:25

    and they did nothing –

    with three hawks dissenting –

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. August 2011 at 10:29

    How does this guy hold a job:


    “Monetary policy is about controlling the supply and price of money, and right now there’s ample supply, and money can be had at a very cheap price.”

  13. Gravatar of Cameron Cameron
    9. August 2011 at 10:43

    On Bloomberg Christina Romer just said the dissents show Bernanke is more willing to work without unanimous agreement (or unanimous agreement-1) and will probably do more soon… that’s the only positive spin I can put on this.

  14. Gravatar of Gabe Gabe
    9. August 2011 at 10:58

    “ideas get momentum, become accepted into the mainstream somehow. You mean to tell me we can convince people to spend $4 trillion in Iraqistan, but not to engage in a stimulative monetary policy? ”

    I tried my best to convince people NOT to spend 4 trillion in Iraqistan. Of course, the owners of the Washington Post, NYT, Fox News, WSJ had more power than me.

    Those same people(who all happen to be members of the CFR) still have more power than me and they have yet to decide to support QE3. They do seem to support higher taxes. Their true goals seem to be to crush the middle class. I hear many of them repeating the meme that our current problems are due to the stubborn republicans who won’t raise taxes.

    The ridiculousness of this claim is underlined by omission of any discussion of monetary policy and the ability of the Fed to create economic conditions such as todays.

  15. Gravatar of Dustin Dustin
    9. August 2011 at 11:16

    “The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

    “Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.”


  16. Gravatar of Catherine Catherine
    9. August 2011 at 11:33

    Apparently Katchlakota is considered a moderate.

  17. Gravatar of dirk dirk
    9. August 2011 at 11:42

    Now I realize that “the Fed bats last” because you always bat the nerdy kid who strikes out every time last.

  18. Gravatar of Jim Glass Jim Glass
    9. August 2011 at 11:52

    Do I read that press release correctly?

    “Everything is worse than we expected and deteriorating. We are going to do nothing about it except what we are already doing which got us here. Three members dissent from this course as doing too much.”

  19. Gravatar of Gabe Gabe
    9. August 2011 at 12:06

    That is how I interpret it Mr Glass.

  20. Gravatar of dirk dirk
    9. August 2011 at 12:08

    Geez, like everyone else here I was disappointed with the Fed announcement today, but now that the market is up so 4% I wonder if the Fed is more clever than we credit them. Since the important thing is that they send the right message, perhaps they managed to signal something positive in some subtle way that only an expert poker player — or a market — could pick up on.

  21. Gravatar of Ram Ram
    9. August 2011 at 12:21

    Immediately after the announcement, the TIPS spread (i.e., expected inflation) plunged, along with the S&P 500. The rest of the session, the TIPS spread rose a bit, but closed somewhat below its pre-announcement level. The S&P 500, however, rallied dramatically. My interpretation is that the announcement effectively tightened monetary policy a bit, but other factors unrelated to Fed policy generated the stock market rally.

    Given that the Fed eased its stance in that it committed to keeping the FFR near zero for two years or so, this suggests that the markets were expecting it to do even more than that. Another possibility is that because the Fed simply stated its intention, rather than credibly committing to it with QE3, the markets didn’t buy what the Fed was selling. A third possibility is that news of three dissenting FOMC members suggests that Bernanke’s inability to get those three to support such a modest move makes the outlook for something more aggressive like QE3 much dimmer. I suspect the negative reaction involved some mix of all three considerations.

  22. Gravatar of JimP JimP
    9. August 2011 at 12:37

    Jim Glass –

    Yes – I also think that is what they are saying. The deflationists have won – both in the Congress and now on the Fed. Neither Bernanke nor Obama are willing to fight.

    Unless Cameron is right – the move to commit to keeping rats low for a stated period of time was enough by itself to produce three dissents – and they did it anyway. Maybe this does mean there is more to come. One can hope. The alternative is despair.

  23. Gravatar of James in london James in london
    9. August 2011 at 13:04

    Growth is overrated. Negative growth is a bit like retirement. US baby-boomers are all now approaching retirement. Just get used to being a tired old world economy like the rest of the West and parts of the East.

  24. Gravatar of MikeDC MikeDC
    9. August 2011 at 13:14

    Well, I’m pretty flummoxed. If someone had told me the Fed would do nothing, indicators suddenly were pointing to deflation, and then the stock market shot up 600 points, I would have told them they were full of it. And yet, that’s exactly what happened.

  25. Gravatar of Lars Christensen Lars Christensen
    9. August 2011 at 13:52

    Well, I would not take the Fed announcement to be so negative. Stocks are up, gold prices are up, the dollar is weaker. It’s all an indication that the markets are reading this as monetary easing. TIPS breakeven inflation is flat – yeah, but the market never really started to believe in deflation (or even disinflation) over the last couple of weeks. To me the drop in NGDP expectations mostly was driven by a drop in RGDP expectations rather than inflation expectations.

    Furthermore, if this works it shows that it is mostly about managing expectations through a clear rule (no rate hike before 2013 – before NGDP return to the old trend??).

    I never was a fan of the credit version of QE – so I clearly prefer this (if it works…).

    I am not sure this is enough to fundamentally get the markets to buy into a NGDP recovery story, but so far so good.

  26. Gravatar of Morgan Warstler Morgan Warstler
    9. August 2011 at 14:26

    There’s a lot of pension funds DESPERATE to find return.

    Returns + safety = impossible

    Technically, I prefer transfers of wealth from Seniors to the young… but this won’t end well.

  27. Gravatar of ssumner ssumner
    10. August 2011 at 10:48

    Gabe, I agree that we need to avoid deflation. Not sure who benefits from it. The “banksters” are being killed by tight money, just like in the 1930s.

    PJ, Exactly.

    dwb, Those are all good points. The only small point I’d add is that even though the Chinese should raise the yuan, doing so won’t have much effect on US inflation.

    Ben, I agree–ideas matter.

    JimP. Yes, even nothing was too much for those three.

    Patrick, It’s amazing how few people understand monetary policy.

    Cameron, Good point.

    Dustin and Catherine, Yes, I’d also heard that Kocherlakota was a moderate. But he was also the one who argued raising interest rates was expansionary. So maybe he thinks he has the dovish position.

    Dirk, That’s a good observation.

    Jim Glass, Yes, that’s right.

    Dirk and Ram and MikeDC, My take is that the market is having trouble figuring out what the low rate promise really means. I have a couple new posts (“transparency” and “epic fail”) that discuss the market reaction.

    Remember the level of stocks is far below a few weeks ago, suggesting that the Fed, at best, made markets slightly less pessimistic about monetary policy. But that failed to offset the large increase in pessimism during recent weeks. In net terms, NGDP expectations are still much lower.

    I didn’t really expect QE3, as that move is always telegraphed. The Jackson Hole conferance may be important.

    James in London, I don’t think unemployment is at all like retirement. One is a happy event, the other is sad.

    Lars, But gold was up even more in the immediate reaction, when the market was down sharply.

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