Lacker on the June meeting

Richmond Fed president Jeffrey Lacker was interviewed by Ylan Mui, of the WaPo:

I never completely make up my mind before a meeting, but at this point it looks to me as if the case for raising rates looks to be pretty strong in June. Inflation is moving decidedly toward 2 percent. Labor markets have tightened very significantly. The concerns, the downside risks that we saw at the very beginning of this year, have dissipated. And we’re very far away from the benchmarks that we have to guide where rates ought to be. To me that adds up to a pretty strong case for a June move. But as I said, I don’t make up my mind until the meeting comes.

Lacker may be right about the need for a rate increase in June, but I don’t see these reasons as being persuasive:

1.  Market forecasts call for under 2% inflation over the next 5 to 10 years.  Those forecasts may be biased, but even Fed forecasts don’t show any overshooting.

2.  Yes, “downside risks” have dissipated, but only because the Fed held off raising rates this year.  Early in the year, the markets were very concerned about the impact of a rate increase on both the US and global economy.  One of the reasons that markets are calm right now is that they view a June rate increase as very unlikely.  I’m not sure that Janet Yellen would like to risk this outcome.

3.  Yes, rates are very far below the levels called for by famous “benchmarks”, but that merely proves that those benchmarks are not reliable in the 21st century.  The Wicksellian equilibrium rate has fallen sharply.  If that were not the case, and the benchmarks still held, we’d be in the midst of another Great Inflation by now.

At the end of the interview Lacker talks about productivity:

I’m optimistic about productivity growth in the longer run. I think productivity growth generally depends on the generation of ideas and the implementation of those ideas. I think we have all the ingredients for generating very useful ideas here. This continues to be a relatively good place to implement good ideas.

I’m less optimistic than Lacker.  Ironically, the strongest argument for a rate increase in June is if you assume that 1.2% RGDP growth is the new normal, as I’ve claimed.  In that case, overheating is more likely to occur with even 3.5% NGDP growth.  In contrast, were RGDP growth to return to the 3% of the 20th century, then current NGDP growth would be too slow, and easier money would be needed going forward, to hit the Fed’s inflation target.


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36 Responses to “Lacker on the June meeting”

  1. Gravatar of LK Beland LK Beland
    16. May 2016 at 05:33

    “Labor markets have tightened very significantly.”

    U-6 is still pretty high (almost as high as during its 2003 peak), and it has plateaued for the past 6 months. There might still be some “animal spirits” in the tank waiting to be released.

    “Inflation is moving decidedly toward 2 percent.”
    In other words, in his opinion (contra market predictions), policy is on track for success. His reaction: let’s preemptively tighten. No wonder these people got stuck in a liquidity trap.

    I would be more concerned and calling for rate hikes if “Inflation [was] moving decidedly toward 4 percent”.

  2. Gravatar of Benjamin Cole Benjamin Cole
    16. May 2016 at 05:35

    You can send in the tweetybirds, or you can send in the whirlybirds.

    Or you can send in Jeffrey Lacker, purging profusely from his rear aperature.

  3. Gravatar of Derivs Derivs
    16. May 2016 at 07:43

    “1. Market forecasts call for under 2% inflation over the next 5 to 10 years. Those forecasts may be biased, but even Fed forecasts don’t show any overshooting.”

    Scott, I thought you insisted to me in January that interest rates were determined by NGDP expectations and NOT inflation. That at 0% inflation no one in their right mind would lend at 5% if NGDP growth was expected to be 18%. So therefore interest rates and inflation expectations, you insisted, are not relevant to one another. Interest rates are connected to NGDP!!!

    So why now are you using yields to calculate inflation expectations???

    Oh, and for shits and giggles I built a ‘lil model (definitely not calibrated but I’d bet it’s pretty close). I calculate based on 5yr paper currently trading 1.25, that in 2021 the market is assessing about a 40% chance of the yield being greater than 2.00 and about a 30% chance of it being above 2.5%.

  4. Gravatar of bill bill
    16. May 2016 at 07:56

    What are the chances that inflation is likely to explode soon when the 10 year Treasury is paying 1.74%?

    OMG! if we have 3 more months of job growth exceeding 100,000, then hyperinflation! [sarcasm]

  5. Gravatar of Oderus Urungus Oderus Urungus
    16. May 2016 at 09:19

    @derivs

    Good luck getting any kind of straight answer out of him.

  6. Gravatar of LK Beland LK Beland
    16. May 2016 at 09:35

    Derivs

    “So why now are you using yields to calculate inflation expectations?”

    He does not look at yields. He looks at yield spreads between TIPS and standard Treasuries. There is a bit of controversy regarding these spreads as reliable inflation indicators (risk premiums, embedded inflation option). But nonetheless, most seem to agree they are useful to gage market sentiment about future inflation.

  7. Gravatar of ssumner ssumner
    16. May 2016 at 12:44

    Oderus, This stuff is too complicated for you to understand. But if you want to try, then read LK.

    Derivs, Take a deep breath and read LK, he explains the difference between rates and rate spreads.

  8. Gravatar of Oderus Urungus Oderus Urungus
    16. May 2016 at 13:49

    Hey Scott, are you ever going to give specific policy recommendations, or just keep repeating slogans that the Fed should do “whatever it takes”? And before you tell me you’ve literally blogged hundreds of times in this, simply provide a link.

  9. Gravatar of Alexander Hamilton Alexander Hamilton
    16. May 2016 at 15:45

    Oderus, I’m astounded that anyone could frequent this blog for any length of time and not know what Scott Sumners policy prescriptions are. He’s like a broken record at times. And it’s not really his responsibility to track down links for every blowhard that appears in this comment section. Although there are some useful links under the “Quick intro to my views” section.

  10. Gravatar of Derivs Derivs
    16. May 2016 at 17:09

    “But nonetheless, most seem to agree they are useful to gage market sentiment about future inflation.”

    YES!!! I am the one who thinks that. It is exactly what yield should be telling you. I even laid out the arb decision tree some time in January.

    “He looks at yield spreads between TIPS and standard Treasuries.”

    The two are HIGHLY connected to one another. I built a quick and dirty fair value model to see how close I could get the two. Over the last 5 years it has always been within 30bps, one lil blip to 40 bps off fair value, but it has usually been within 15bps. Essentially, what I am saying is they are near substitutes. If 10yr Treasuries went to 4.5%, TIPS should go somewhere near 1.80. The two are most certainly not independent of one another. So if you are using TIPs or Treasuries, you are respecting that bond yield has SOMETHING to do with pricing off inflation expectations, Scott was VERY clear only NGDP determines yield.

    I am waiting for the example of ANY country that has ever had stagflation. Scott was completely correct, Brasil was close to 5% NGDP growth. +3.7% to be exact. But inflation was 10% and yields went to 16%. Not exactly moving with NGDP. Moving with inflation.

    A BOND IS SIMPLY A CASH TIMESPREAD!!!!

    “Derivs, Take a deep breath”

    LOL, it seems this is a trigger issue for me.

  11. Gravatar of Oderus Urungus Oderus Urungus
    16. May 2016 at 17:46

    @hamilton

    You mean those articles where he exhorts the Fed to announce “credible” targets that they “commit” to meeting, and do “aggressive” QE? Yeah, real specific.

    Simple question. Imagine a dystopia where Sumner is Fed chairman (I suppose he’d call it Chairperson). I’m guessing he ends IOER, I’ll grant that’s a specific policy (although he completely misunderstands it). What’s next? What exactly does he do? No hand-waving, actual actions.

  12. Gravatar of dtoh dtoh
    16. May 2016 at 18:05

    @scott,

    Why do you assume 1.2% RGDP is the new normal. If the Fed can hit any NGDP target it wants and if the market is right about 2% inflation, why not target 7% NGDP and make 5% RGDP the new normal?

  13. Gravatar of Oderus Urungus Oderus Urungus
    16. May 2016 at 18:22

    BTW, what exactly is the current level of the Wicksellian natural rate (something Sumner claims to never make use of yet uses it all the time)?

  14. Gravatar of Seo Sanghyeon Seo Sanghyeon
    16. May 2016 at 22:04

    Oderus, here I simply provide you a link: https://www.themoneyillusion.com/?page_id=3447 which is titled “FAQs”.

    As you already pointed out, one specific policy recommendation is to end IOER. Next, subsidized NGDP futures market is established. And then Fed announces NGDP target and that Fed will do level targeting. If market disagrees with target, aggresive QE is done until market agrees.

  15. Gravatar of Seo Sanghyeon Seo Sanghyeon
    16. May 2016 at 22:11

    dtoh, Fed can hit any NGDP target, but that does not mean Fed can cause any RGDP growth. If 1.2% RGDP is the new normal, 7% NGDP target causes 5.8% inflation. The market is right about 2% inflation now. After 7% NGDP target is announced, the market updates from this new information and adjusts inflation expectation to >5%.

  16. Gravatar of dtoh dtoh
    16. May 2016 at 22:45

    Seo,

    So any increase in NGDP will all be nominal? Essentially RGDP is capped at 1.2% regardless of NGDP growth?

  17. Gravatar of Derivs Derivs
    17. May 2016 at 03:21

    “Essentially RGDP is capped at 1.2% regardless of NGDP growth?”

    I’ve never seen anyone put the 2 together, but shouldn’t RGDP move pretty much with productivity gains as some sort of a soft cap? On an individual level this seems to make sense.

    LK. slightly more coherent way of saying what I tried to last night.

    A 5 yr Treasury is Fixed inflation plus a premium.
    A 5 yr TIPS is Floating inflation plus the TIP premium.
    At time 0 (now, instantaneous) one can only have 1 inflation expectation for May 2021.
    So at t0 both TIPS and Treasuries must be valued with the same inflation expectation.
    Therefore that ‘same’ inflation expectation is being used for both and can be stripped from the Treasury or added to TIPs to test for comparability. THEY SHARE THE SAME INFLATION EXPECTATION. ONE IS JUST FLOATING AND THE OTHER IS FIXED! But at T0 they must be the same expectation.

    The two products are substitutes. Both share today’s expected inflation rate. Maybe thinking of it as trading a 1 day treasury vs a 1 day tips would make it more obvious. They are not just randomly priced mutually exclusive to one another.

  18. Gravatar of Oderus Urungus Oderus Urungus
    17. May 2016 at 03:56

    @Seo

    Thank you. I will take this to be the canonical market monetarist position. It is incoherent (do you actually know why liquid futures markets are informationally efficient) and question-begging (assume a can opener type stuff), but it is indeed clearly laid out.

    BTW, why do you believe the Fed can hit any NGDP target?

  19. Gravatar of dtoh dtoh
    17. May 2016 at 05:20

    @Seo
    So a) you don’t think RGDP growth has anything to do with investment and by extension b) expected NGDP growth and c) the price of financial assets?

  20. Gravatar of TravisV TravisV
    17. May 2016 at 05:39

    Will Wilkinson on Deirdre McCloskey:

    http://evonomics.com/leading-libertarian-says-social-justice-is-the-cause-and-effect

    “Rethinking Libertarianism: Social Justice and The Great Enrichment”

  21. Gravatar of LK Beland LK Beland
    17. May 2016 at 05:43

    Derivs
    “Both share today’s expected inflation rate”

    Yes. This is exactly why their spread is a measure of inflation expectations.

    In a better world, the government would also finance itself using NGDP-based Treasuries, which would provide information about NGDP expectations.

  22. Gravatar of Majromax Majromax
    17. May 2016 at 06:04

    @Dervis:

    You are incorrect in your expression of TIPS valuations, where you say “TIPS […] must be valued with the same inflation expectation.” Since TIPS have actual inflation built into the return, their present valuation is indifferent to inflation expectations (notwithstanding the implicit inflation option).

    If I strongly believe that the marginal real rate is 2%, then I would value a $100 one-year, zero-coupon TIPS at $98, regardless of whether I expect the next year’s inflation to be 1% or 100%. My inflation expectations would obviously enter for a nominal bond.

  23. Gravatar of LK Beland LK Beland
    17. May 2016 at 06:08

    dtoh

    Good point about investments being driven by expectations. This might explain why productivity growth has been so poor since the recession. In fact, real private fixed nonresidential investments per worker still have not reached their former peak.

  24. Gravatar of Derivs Derivs
    17. May 2016 at 09:22

    “Since TIPS have actual inflation built into the return, their present valuation is indifferent to inflation expectations”

    “If I strongly believe that…”

    Your belief is irrelevant for valuation purposes. For valuation purposes you marry random walk theory and just accept you know nothing and that outcome can be 50/50 higher/lower. Therefore at t0 there is no benefit to taking fixed over float. They trade at 1 price. By synthetic replication it would be acceptable to substitute one for the other if you do see a floating component in a structure. And if you had a specific number for expected inflation, and there was a put and a call on it, they would trade for the same price because the maths don’t care if you think the call should be worth more. Your personal opinion has nothing to do with valuation, it has to do with which side of a trade you might decide to take, and my strongest recommendation is to never really think too much of your own opinion as far as guessing market direction.

    All you want to do is look at expected value of payout structure as it appears today. This one is easy as it is the same entity that you are lending to and that will be paying you back, and the time frames are equivalent as well. Therefore the best one to take is the one that offers the better payout today as current value = expected value. The two can only get so far apart (to me it seems about 30bps…).

    So if inflation expectations are 4% and Treasuries are 6% and TIPS are 3.5%. Something is too far out of whack.

    Outcome is also irrelevant, I have already stated one is simply a fixed instrument the other is floating. But fact is that fixed and float trade today at the same price. So all that matters is expected value today. If I were to tell you that inflation expectations are 4% and Treasuries are

  25. Gravatar of Derivs Derivs
    17. May 2016 at 09:24

    ignore that last paragraph.. it was redundant from something i had re written above it…

  26. Gravatar of Postkey Postkey
    17. May 2016 at 14:50

    “Good point about investments being driven by expectations. This might explain why productivity growth has been so poor since the recession.”

    Productivity growth has also been poor in the UK, despite the increase in investment?

    “The depth of the crisis was reached in the spring and summer of 2009, and we now have the initial estimates for the economy for the same period in 2015. GDP as a whole increased by £100bn over the period, after allowing for inflation, a rise of nearly 13 per cent. Companies spent an additional £32bn on new investment in 2015 compared to the same period six years ago. In percentage terms, this was by far the fastest growing sector of the economy, up by 26 per cent. By contrast, consumer spending grew by only 10 per cent, less than the economy as a whole. It has been an investment-led recovery, with the role of public spending negligible. “
    http://www.cityam.com/231763/ignore-the-gloom-merchants-the-uks-investment-led-recovery-is-sustainable

  27. Gravatar of LK Beland LK Beland
    18. May 2016 at 05:47

    Postkey

    Investments have been very poor in the UK during the 2008-2014 period:

    http://www.ons.gov.uk/economy/grossdomesticproductgdp/bulletins/businessinvestment/quarter4octtodec2015revisedresults

  28. Gravatar of ssumner ssumner
    18. May 2016 at 05:50

    Oderus, Google my paper on NGDP futures targeting (link in right column). Although I doubt you’ll be able to understand it.

    Derivs, In the US in 2007-08, yields moved with NGDP growth, which slowed, not inflation, which increased.

    dtoh, If the Fed raises NGDP growth to 7%, inflation will rise to 5.8%.

    Seo is right, on your second question monetary policy does not determine real growth in the long run—at best it provides a temporary boost.

    Read Gregory Clark’s review of Gordon’s book, it explains why slow growth is here to stay (for decades)

    Travis, Good essay.

  29. Gravatar of Alexander Hamilton Alexander Hamilton
    18. May 2016 at 12:11

    Oderus, Why don’t you enlighten us about what Scott doesn’t understand? This should be good.

    I think we’ve got someone new to entertain us.

  30. Gravatar of Oderus Urungus Oderus Urungus
    18. May 2016 at 13:19

    He (and all market monetarists) believes IOER is a barrier to lending by the banks, which is something the Fed and Bernanke himself have clearly refuted. But it doesn’t fit his narrative so he chooses to ignore it (which is odd because he’s usually a shameless Fed nut-hugger).

  31. Gravatar of dtoh dtoh
    18. May 2016 at 16:09

    @scott
    Do you really believe real growth is now capped at 1.2% and any growth beyond that will be 100% nominal.

    Can we now add it to the growing list of unbreakable boundaries…

    – Edge of the earthy
    – Sound barrier
    – ZLB
    – Cap on real growth

  32. Gravatar of ssumner ssumner
    19. May 2016 at 08:51

    Oderus, No, I don’t view IOR as a barrier to lending, I view it as something that boosts demand for base money, as does Bernanke. When IOR was enacted the Fed say it was intended to be contractionary. I think the Fed was correct, it was contractionary.

    dtoh, Yes, I think that monetary policy cannot cause growth to go above 1.2% in the long run, nor can monetary policy cause rockets to break the sound barrier.

    Other policies can cause faster than 1.2% growth, and other policies can cause rockets to break the sound barrier.

  33. Gravatar of dtoh dtoh
    19. May 2016 at 11:37

    @scott
    Define long run.

  34. Gravatar of Alexander Hamilton Alexander Hamilton
    19. May 2016 at 12:07

    Oderus, This kind of discussion is way over your head. By all means keep thrashing around in the dark. It’s entertaining at least.

  35. Gravatar of Oderus Urungus Oderus Urungus
    19. May 2016 at 18:03

    Scott, you can’t even lie well. Here:

    https://www.themoneyillusion.com/?page_id=3447

    you write:

    “The Fed should stop paying interest on excess reserves, and if necessary should put a small interest penalty on excess reserves. This would encourage banks to stop sitting on all the money that has been injected into the system.”

    You’re seriously denying you view IOER as an opportunity cost, an impediment to banks lending? You certainly don’t disabuse your idiot fanboys of this viewpoint.

    At any rate, your statement here about base money is exactly the point. IOER was implemented AFTER QE was initiated, i.e. after the Fed flooded the banking system with reserves that were not wanted and threatened to drive the Federal Funds rate down to zero. It was concern over losing control over this rate that put IOER
    into service. The Fed (and Bernanke) has made this very clear. Your claim that they viewed that as “contractionary” (don’t give us rubbbish about “contractionary intent”, that’s the expectation fairy talking) is just your selective interpretation. Far from counteracting QE, IOER is actually an acknowledgment of its failure.

  36. Gravatar of dtoh dtoh
    19. May 2016 at 20:32

    @scott
    “I think that monetary policy cannot cause growth to go above 1.2%”

    I assume this your contention is that monetary policy can not raise RGDP growth rates over the long run. If so, what is wrong with the following logic.

    1. Fed can achieve an NGDP target.

    2. If Fed achieves NGDP target, business cycle will be reduced with less volatility in RGDP growth.

    3. Reduced RGDP/NGDP volatility reduces risk on investment and improves risk adjusted returns.

    4. Higher returns leads to higher investment.

    5. Higher investment leads to higher real growth.

    Am I missing something.

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