Am I the only person who believes . . .

. . . that the Fed was correct in raising rates this past December.

And that the Fed should cut interest rates later this year?

Most people have an agenda, hawkish or dovish. I’m not a hawk or a dove; I want stable monetary policy. But interest rates are not monetary policy; they are one of the effects of monetary policy. A stable monetary policy will feature interest rates following a path that looks fairly random, rising and falling with unexpected changes in inflation and growth.

The US economy was quite strong last year, and is widely expected to be a bit weaker this year. That suggests that the optimal interest rate at the end of last year might have been a bit higher than the optimal rate in 2017, but also a bit higher than the optimal rate in 2020. Rates should fluctuate while NGDP growth should be stable.

Of course the Fed actually targets both inflation and employment, not just inflation. Most private sector forecasts call for slightly below 2% inflation this year and slightly above normal employment rates this years (relative to the Fed’s estimate of the natural rate.) Overall, policy seems pretty close to being on target.

When the Fed raised rates in December, I did not criticize the decision. But I did criticize their December decision to signal several more rate increases this year. Since then, the Fed has come around to the market view that further rate increases are not needed.

You may wonder why I favor a rate cut later this year. It’s partly because the fed funds futures market forecasts a rate cut. But the market forecast is not enough, as MMs care about market forecasts of the goal variables more than market forecasts of the policy instrument. More precisely, MMs care about the market forecast of the instrument setting expected to lead to on-target policy goals (inflation, NGDP, etc.)

Because markets continue to forecast slightly below 2% inflation, even as the economy slows, the market forecast of an interest rate cut should be taken as evidence that a rate cut is probably needed at some point this year. If the market were forecasting a rate cut combined with 3% inflation, then I would not blindly adopt the market forecast as my own policy preference.

Again, interest rates are not monetary policy; NGDP growth expectations are monetary policy.

Not a hawk or a dove

PS. Today’s new unemployment claims report is insanely low (202,000), underscoring that the labor market is still really strong. I doubt that there’ll be a recession this year.


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36 Responses to “Am I the only person who believes . . .”

  1. Gravatar of bill bill
    4. April 2019 at 11:17

    Until we get an NGDP futures market, which market price(s) are the best substitute?

  2. Gravatar of stoneybatter stoneybatter
    4. April 2019 at 11:34

    In fourth paragraph, I think you mean LOWER.

    “but also a bit HIGHER than the optimal rate in 2020”

    But good post overall.

  3. Gravatar of Justin Justin
    4. April 2019 at 14:09

    Point taken that the Fed Funds rate should be more or less unpredictable. That’s how it’d look if overnight rates floated freely, while monetary base adjustments were used as the instrument.

    However the other claims in this post are off base. “and is widely expected to be a bit weaker this year” This is a big understatement. We had around 5% NGDP growth in 2018, it was a normal year, every year should look like 2018. In 2019, we’ll be lucky to get 3.5% for the year; that’s a big drop, a jarring drop that wasn’t expected. Cruel and unusual to do this to business leaders and workers. People made plans in 2017 that assumed 4%+ nominal growth through the early 2020s.

    More to the point, there was no justification for raising rates in December 2018. Q4 was a disaster for NGDP expectations, my forecast engine (ngdp-advisers.com/ngdp-forecast-client/) had market expectations sinking from 4.7% at the start of the quarter, to 3.5% on Dec 19, the day before the Fed boosted rates. The bear market in E[NGDP] in Q4 is a record of the market warning the Fed not to raise rates. 2018 saw the labor fore participation rate and wages rise, while inflation remained, not only within the rage of the 90s and 00s, it was too low to plausibly make up for a decade of inflation undershooting. It look 5% NGDP growth to get us wage and LFPR gains, there’s little case for anything less than 5% NGDP.

  4. Gravatar of ssumner ssumner
    4. April 2019 at 16:22

    Bill, I look at many different markets, including stocks, TIPS, bond yields, private consensus forecasts, etc.

    Stoneybatter, No, I meant 2018 rates should be higher than 2020.

    Justin, With 5% NGDP growth they won’t be able to hit their inflation target. I’d be happy with a 5% NGDP target, but that’s not current Fed policy. Whatever they target, they need to hit it.

    People have been expecting a slowdown for quite some time. Judging by the stock market and the labor market, it’s not a big shock to companies and workers.

  5. Gravatar of Michael Sandifer Michael Sandifer
    4. April 2019 at 18:50

    Scott,

    I think it’s unfair to broadly characterize many of us who’ve long thought policy is too loose or too tight as having an agenda. Many of us just disagree with your interpretation of the data over the past couple of years. It’s not as if any of us has an open and shut case with the paucity of relevant data available.

    While I think monetary policy has been too tight for at least 19 years, I think it tightened relatively acutely, beginning around October of last year, as I indicated at the time. The telltale for me included the falling S&P 500 P/E, with earnings rising; decreased forecasts for market rate hikes for this year; falling TIPS spreads; etc. There was every indication growth expectations were slowing even while the current numbers last fall looked good.

    As you’ve admonished many times, monetary policy should be forward-looking and inflation is hard to measure and isn’t a good indicator of the stance of monetary policy. I think I was right, based on market monetary principles I learned, in part, by reading this blog.

    I also still think I was right about monetary policy being too tight, even in September of last year. When I was saying it a couple of years ago, I was part of a minority of people with that view. I think falling unemployment since then has been consistent with, though has not uniquely supported that view. I do think however, once again, that those who thought monetary policy wasn’t tight two years ago have been proven wrong.

  6. Gravatar of Michael Sandifer Michael Sandifer
    4. April 2019 at 18:54

    I should clarify and say that falling unemployment over the past two years is consistent with the model I use to decide whether monetary policy as the economy near equilibrium, but does not support my model in a unique way. Other models are also supported. But, no model that had monetary policy being too tight or just about right is supported by the data since.

  7. Gravatar of Benjamin Cole Benjamin Cole
    5. April 2019 at 02:28

    “Am I the only person who believes . . that the Fed was correct in raising rates this past December?” (sung to the tune of “Eve of Destruction”).

    Well, let us put this way: Tim Duy is calling the Fed December rate hike one of the biggest Fed boners since 2006-9.

    Yes, I have been “dovish” since I started this unhealthy obsession with monetary policy 10-12 years ago. But I have been right! I was right going into the Great Recession, I was right through of dreary molasses recovery and I am right now.

    —-

    BTW . . . By Stanley White

    TOKYO (Reuters) – Japan’s household spending rose less than expected in February and real wages tumbled at the fastest pace in more than three years, raising concerns about the hit to the consumer sector from heightening global uncertainties.

    —30—

    Nominal wages in Japan in February, year-over-year were down 0.8%. Real wages down 1.1%.

    Gadzooks! Are we sure QE works, even with a small side dish of negative interest rates? And Japan banks say they cannot make money with such small spreads. But when banks do not make money, they lend less. Less capital. Less lending means less endogenous money creation.

    Dudes: As long as you emblazon “We Fear Inflation” your escutcheons, you will not get Western economies running full-throttle again.

  8. Gravatar of stoneybatter stoneybatter
    5. April 2019 at 04:48

    Scott, I misread! Thank you for the response.

  9. Gravatar of Brian Donohue Brian Donohue
    5. April 2019 at 05:04

    No, you are not alone. Anyone paying attention understands that the issue last December was not the well-telegraphed rate hike, but the hawkish forward guidance, which Powell walked back pretty quickly.

    It’s not obvious to me the Fed cuts rates this year. Facts on the ground change all the time, situation is, always, fluid. When the time comes, why not consider reducing IOER as the first step in the next cycle of policy loosening?

  10. Gravatar of P Burgos P Burgos
    5. April 2019 at 05:36

    An owl is still a bird of prey, so kind of like a hawk. I would have chosen a bat, because it still flies, but isn’t a bird. Then Prof. Sumner could call himself the “batman” of monetary policy.

  11. Gravatar of Dilip Dilip
    5. April 2019 at 07:07

    Who is Benjamin Cole? I am routinely flummoxed by his posts here.

  12. Gravatar of ssumner ssumner
    5. April 2019 at 12:17

    Michael, An “agenda” in a non-perjorative sense. Certainly I prefer long time doves to people who were hawkish under Obama and suddenly turned dovish under Trump. Hmm, who can I be thinking of?

    You said:

    “I think falling unemployment since then has been consistent with, though has not uniquely supported that view.”

    I just don’t understand this argument. Are you saying that unemployment would not have fallen if we had adopted what you view as the optimal policy? If not, how can it show that money was too tight? Unemployment fell in the late 1960s—was money too tight at that time?

    Brian, I agree that it’s not obvious the Fed will cut rates this year. It’s probably the wise move, but it’s hard to be sure. The economy may end up stronger than markets currently assume.

    Burgos, But owls are very wise.

  13. Gravatar of Michael Sandifer Michael Sandifer
    5. April 2019 at 13:00

    Scott,

    You replied:

    “I just don’t understand this argument. Are you saying that unemployment would not have fallen if we had adopted what you view as the optimal policy? If not, how can it show that money was too tight? Unemployment fell in the late 1960s—was money too tight at that time?”

    My argument is that we were obviously not at full employment two years ago, and that unemployment would have fallen faster with looser money.

    I understand, of course, that under an inflation targeting regime, the point is to target inflation, in the case of the Fed, at 2%. You like to write posts on whether you think the Fed’s hitting their inflation target, which is a separate question from whether monetary policy has us near equilibrium. I personally think it’s a distraction. It’s clear, in retrospect, that we could have used some higher inflation, which we would have had with a 5% NGDP level target.

    If you think the interest rate increase in December was okay, you’re arguing with the markets, as I interpret it.

  14. Gravatar of Benjamin Cole Benjamin Cole
    5. April 2019 at 16:16

    Dilip: I am me. I am sorry to flummoxed you. While wearing a cape, I have thwarted and foiled many. But in commenting on a monetary policy blog, I usually just wear civilian clothing.

    Are you an orthodox macroeconomist?

    If so Dilip, it is not I who has flummoxed you, but reality itself.

  15. Gravatar of ssumner ssumner
    6. April 2019 at 07:03

    Michael, You said:

    “My argument is that we were obviously not at full employment two years ago, and that unemployment would have fallen faster with looser money.”

    I’ll take that as a “yes.” So you are claiming that falling unemployment shows money was too tight in the late 1960s. I think that’s just nuts.

    And I’m not “arguing with the markets” on the December rate increase, it was the after announcement comments that caused the market selloff. I criticized those at the time.

    The Fed is currently very close to its target, arguably right on its target. You may favor 5% NGDP, but that’s not the target.

  16. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 08:10

    Scott,

    Of course money was too tight in the late 60s. That’s why 1970 began with a recession. Why would you think otherwise?

    Just because inflation had started to take off, doesn’t mean money’s loose. Again, using your own principle, inflation is not a good indicator of the stance of monetary policy.

    IF you look at the below graph, you see the effective Fed Funds rate was also rising fast in the late 60s. I’m guessing the Fed panicked when they saw “high” inflation, and caused the 1970 recession. Things are the same as they ever were.

    https://fred.stlouisfed.org/graph/fredgraph.png?g=nxHo

  17. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 08:21

    Here’s that graph zoomed in, to be easier on the eyes:

    https://fred.stlouisfed.org/graph/fredgraph.png?g=nxHz

  18. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 08:26

    And here’s the link for the graph, to make it easy to use it for a counter-argument:

    https://fred.stlouisfed.org/series/UNRATE/#0

  19. Gravatar of P Burgos P Burgos
    6. April 2019 at 10:24

    Batman isn’t wise?

  20. Gravatar of ssumner ssumner
    6. April 2019 at 10:59

    Michael, Monetary policy in the late 1960s triggered the Great Inflation. It pushed inflation from 2% to 6%, and NGDP growth soared to 10% by the late 1960s. It was far too expansionary. The recession occurred because an overstimulated economy will eventually revert back to the natural rate of output, just as Milton Friedman predicted in 1968.

  21. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 13:10

    Scott,

    We apparently have different definitions of “tight” and “loose” money. I think policy was clearly tight in 1968 and ’69, for example, because the Fed trying to reign in inflation. If NGDP is falling, I consider monetary policy to be tight, for example. “Tight” is just a label, but that’s how I use the label. It can also apply when I think sustainable economic growth could be higher, if monetary policy were looser.

    This doesn’t mean I always think it’s necessarily bad to have tight money. I think it’s sometimes necessary to slow NGDP when inflation is high, as real growth will begin to grind down, eventually. Some of that may have been needed in the late 60s, but I’m not convinced, and I think the Fed went too far, even if tight money was needed.

    On the other hand, a look at NGDP versus GDP in from the mid-60’s to the early 80’s is consistent with your story. That is, of real GDP grinding down due to high inflation. I was under the impression that wasn’t responsible for the recessions during the period. I still think they were Fed-induced.

    To me, the “Great Inflation” was not so much an inflation, as a period of relatively high instability in monetary policy. Also, as you probably know, you’re rather unique in claiming the Great Inflation began in the 60’s. Most consider the beginning to be under Nixon, but I think the evidence is consistent with your story in that respect.

    Your story looks consistent with this data, which is essentially a way of visualizing a measure of inflation:

    https://fred.stlouisfed.org/graph/?g=nxPz

    But, add the FFR data, and it appears more consistent with mine, in my view.

    https://fred.stlouisfed.org/graph/?g=nxPc

  22. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 13:22

    To correct the above, Great Inflation began for many when Nixon pressured Burns to help him get re-elected. Obviously, Nixon was elected in ’68.

  23. Gravatar of Matthew Waters Matthew Waters
    6. April 2019 at 14:40

    PCE went up to 4% growth in 1968, before Nixon became President and Burns became Fed chair. There were clashes between LBJ and Martin which look like Nixon/Burns or Trump/Powell. (Remove spaces in link)

    https:// http://www.nytimes .com/2017/06/13/business/economy/a-president-at-war-with-his-fed-chief-5-decades-before-trump.html

    I won’t say I’m an expert on Martin. But it seems like Martin institutionalized many wrong things the Fed believes, even after Volker. The FOMC looks at a “wide range of economic variables” instead of targeting one. The Fed “takes the punch bowl away.” After 2008, these sayings have justified too tight rather than too loose policy. But the sayings have been the same.

  24. Gravatar of Matthew Waters Matthew Waters
    6. April 2019 at 14:42

    Sorry, I’ll try copying the link for this comment and see if it doesn’t get swallowed.

    https://www.nytimes.com/2017/06/13/business/economy/a-president-at-war-with-his-fed-chief-5-decades-before-trump.html

  25. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 14:58

    Matthew Waters,

    Very interesting. Yes, just glancing at the data, if you want to call the period “The Great Inflation”, it seems very compelling to say it started in the 60s. I don’t argue with the framing temporally, but I always saw the period as one with the Fed “over-steering”, to borrow a metaphor from Scott. They caused brief bursts of high NGDP, and then crashed the economy, repeatedly, until we finally started to see inflation trend lower, on average, as we entered the Great Moderation.

    Perhaps I’m incorrect and my view is crude, but I wonder where the evidence is that RGDP was grinding down in the late 60s due to high inflation, rather than the Fed crashing the economy with the Fed Funds rate soaring. It is interesting that inflation remained high during the 1970 recession, but inflation didn’t fall much during recessions in 1991 or 2001 either. We’re those also caused by prior high inflation?

    I’m not convinced.

  26. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 15:03

    By the way, 5% inflation wasn’t considered high in the 80s, though, to be fair,nthe average long-term trend was heading down rather than up. Still, I don’t recall hearing anyone say 5% inflation would eventually cause a recession, as real GDP ground down due to inflation.

  27. Gravatar of Michael Sandifer Michael Sandifer
    6. April 2019 at 15:10

    Scott,

    I concede your point that the rate hike itself did not cause a market selloff last December. My memory was faulty. The well-off occurred that day not after news of the rate hike, but after Powell’s press conference. And Fed Funds Futures had largely priced in the rate increase.

    Of course, a quarter point change isn’t much in isolation, so it’s always the long-term signals that really matter.

  28. Gravatar of Matthew Waters Matthew Waters
    6. April 2019 at 19:13

    Michael,

    The supply-side issues caused inflation to go up in 1969-70 which then caused the Fed to increase rates. The Fed could not have caused the supply-side to become more inefficient and raise prices.

    I could not find a good explanation of the 1970 recession and the supply-side issues. Oil prices were flat. I have some theories about the supply-side issues, but do not want the comment to go too long. The supply-side is far more difficult.

    Also, I charted NGDP/(civilian labor force), PCE and PCE core here. If judged by NGDP/worker, Martin actually had NGDP grow too slowly in 1970 and too quickly in 1966 and 1968. NGDP/Worker grew at over 8% in 1968, close to the peaks of Burns’ levels. Volker actually had the highest YoY NGDP/worker growth of any quarter, in 1980.

    https://fred.stlouisfed.org/graph/?g=nxXj

    On another note, both PCE and PCE Core look like bad variables for monetary policy in the short-run. The 1991 and 2001 recession both had flat inflation but low NGDP/worker growth. Even though some pain was inevitable in the early-80’s, NGDP/worker growth in 1982 did not need to go down to 1.4%. In some magical world where Volker strictly targeted 5% growth NGDP/worker, inflation would have still gone down.

  29. Gravatar of Michael Sandifer Michael Sandifer
    7. April 2019 at 07:38

    Matthew Waters,

    High inflation for extended periods can have negative supply-side effects. Bracket creep is an example. Since the US has taxes on nominal incomes, higher inflation more rapidly pushes more people into higher tax brackets, presumably lowering RGDP potential.

    My understanding is that increases in inflation can temporarily increase employment over the natural rate. This can temporarily increase real output. The effect is temporary, because wages and other prices adjust. This involves the short-run aggregate supply curve, before long-run expectations for higher inflation take hold. Then, to prevent a reversion to the natural rate of RGDP growth, additional positive nominal shocks are required, which if continued, lead to an spiraling of inflation and a grinding down of RDGP. That’s the formula for stagflation.

    Of course, my understanding might be wrong, but I don’t doubt that high inflation can cause temporarily unstainable RGDP growth which will revert to the natural rate. My doubt is over whether inflation was high enough, long enough in the 60s to cause that problem by 1970.

  30. Gravatar of Michael Sandifer Michael Sandifer
    7. April 2019 at 07:51

    I should include a bit more context here. I am skeptical of estimates of natural unemployment rates and potential RGDP. I think the NAIRU is lower than commonly believed, and RGDP potential higher. I don’t think looking at average or historical highs or lows of RGDP growth rates or unemployment rates, even over extended periods, is necessarily very useful. In the context of always having had bad monetary policy, there is great uncertainty.

  31. Gravatar of Michael Sandifer Michael Sandifer
    8. April 2019 at 03:09

    Scott,

    Even if I conceded your point about the 60s, then it means my model’s flawed, but does that actually help your argument in the post? Do you have any reason to believe the unemployment rate has fallen in an unsustainable way? You’ve said.yourself that you would have been okay with a 5% NGDP level targeting, even over the past two years, which is what I’m advocating. So, how then is it not wrong to say that money’s been tight over the past two years as unemployment’s continued to fall? Would a higher rate of the fall of unemployment been unsustainable?

    This is where the disconnect is for me. As far as I can tell, every other market monetarist thinks policy has remained too tight over the past couple of years, and is tight now.

  32. Gravatar of ssumner ssumner
    8. April 2019 at 08:20

    Michael, You said:

    “If NGDP is falling, I consider monetary policy to be tight, for example.”

    It wasn’t falling, it was growing at 10%/year.

    You said:

    “Also, as you probably know, you’re rather unique in claiming the Great Inflation began in the 60’s.”

    No, the standard view is that it began in the 1960s.

    Matthew, In my view, high wage growth caused the 1970 recession, as workers caught up to the previous inflation. Think of the SRAS curve shifting back to the natural rate, reducing output.

  33. Gravatar of Michael Sandifer Michael Sandifer
    8. April 2019 at 08:25

    Scott,

    Yes, I was referring to the recession in 1970. If the Fed didn’t want NGDP to fall, it wouldn’t have.

  34. Gravatar of Michael Sandifer Michael Sandifer
    8. April 2019 at 08:55

    Scott,

    60s aside, would you say that higher NGDP growth over the past two years would have been unsustainable. If so, why?

  35. Gravatar of Michael Sandifer Michael Sandifer
    11. April 2019 at 08:56

    Scott,

    We’ve been going back and forth on this for around 2 years. Perhaps we can put it to rest.

    Have you thought monetary policy was mostly roughly appropriate for a 2% targeting regime because of your estimate of sustainable potential RGDP? If so, with unemployment having continued to fall since, with low inflation, does that not mean a revision of that prior RGDP growth potential is required?

    I can understand thinking RGDP potential is lower, due to slowing of the growth of the working age population. What I don’t understand is why we couldn’t have had temporarily higher inflation spurring more RGDP growth until the unemployment rate fell more quickly toward the natural limit.

  36. Gravatar of Michael Sandifer Michael Sandifer
    11. April 2019 at 09:35

    And let me correct an error in my statement above. I apologize for some sloppy statements.

    It’s not that you would need to revise down the long-run growth potential estimate, but just to say that the economy was not at full capacity during the last couple of years. Perhaps the long-run real growth potential will settle down to roughly 2%, after reaching full-employment.

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