The Fed is clumsy
The Fed should not be targeting interest rates. But if it insists on doing so, then the most efficient regime would adjust the fed funds rate target by basis points (i.e., 0.01%), not quarter point increments. In addition, the rate should be adjusted daily based on the median vote of the FOMC. It should move around like a market price, rising and falling unexpectedly as new information comes in each day.
Instead, the Fed has adopted a clumsy procedure of quarter point adjustments every 6 weeks. Even worse, they’ve made the system even more clumsy by investing inflection points with vast significance:
Chair Jerome Powell, who is speaking later Friday, has stressed the need for patience, saying the timing of the first rate cut would be “highly consequential.” Policymakers will have access to one more PCE report, in addition to others on consumer and producer prices as well as employment, before their next meeting starts on April 30.
PS. Here’s a prediction for 2024: Inflation will remain above the Fed’s target, disappointing those who expected a soft landing. The economics profession will fall all over itself making up phony “supply-side” excuses for the lack of progress against inflation (which has obviously been a mostly demand side problem, and will remain so in 2024.)
As always, watch the NGDP growth rate, which remains too high. From the same Bloomberg article:
“We really just haven’t seen that consumer fatigue that we were getting some hints of in the last month’s data,” said Sarah House, senior economist at Wells Fargo & Co. “That’s going to make it really hard, I think, for businesses to hold the line on prices if consumers are still willing to splash out at these levels.”
Translation: If NGDP growth remains high, the inflation will persist.
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29. March 2024 at 11:18
What are the odds inflation is at target, and neither below nor above?
29. March 2024 at 14:56
Lizard, Low. It’s above target.
29. March 2024 at 15:50
It is interesting that some central banks raise or lower interest rates by a tenth of a percent, and meet monthly. The Federal Reserve seems to regard traditions from centuries past, from the pre-telephone era, as sacred
With the advent of zoom conferencing, one could imagine meeting more frequently and altering rates by much smaller amounts.
I am still not convinced monetary policy is an effective tool, all by its lonesome. If we have globalized economies and globalized financial markets and globalized capital markets then the effects of any particular central bank could be diluted.
In addition, housing costs seem to play havoc with the way inflation is measured.
30. March 2024 at 02:52
NGDP is still too high, as is inflation, but both have been trending down. The NGDP growth downtrend has decelerated, so more tightening may be needed.
Forward indicators look much better, though even inflation expectations are a bit too high now. Forecasts of the S&P 500 earnings yield has it trending up over the next several quarters, while the yield curve is inverted, which are strong indications that NGDP growth is expected to slow further.
So, while the Fed has allowed monetary policy to loosen a bit lately, the path is still not terrible, even if a bit hot.
30. March 2024 at 04:35
What do you think about things like the obvious slowdown in car manufacturing taking time to make its way into the economy? Seems to me that elements of inflation still on the rise are playing catch up: insurance catching up to ridiculously expensive vehicles people over extended themselves for, for example.
30. March 2024 at 08:17
@Solon: “If we have globalized economies and globalized financial markets and globalized capital markets then the effects of any particular central bank could be diluted.”
No. You are confusing the real economy with the nominal economy. “Globalized” things affect the flow of real goods and services. But that is completely irrelevant for inflation. The central bank is the sole monopoly provider of the domestic economy’s money supply, and as such is in control of the domestic economy’s inflation. Globalized flows (“real”) have nothing to do with the value of local currency (“nominal”).
30. March 2024 at 08:31
Michael, I mostly agree.
Sam, That sounds right, but it’s best not to focus on individual prices, rather look at NGDP and aggregate wages for the deeper trends.
30. March 2024 at 18:55
Scott,
If you look at the NGDP-minus-S&P 500 earnings chart on my March 29th post here, you’ll see I adjusted that metric by using concurrent quarter earnings rather than that of the trailing 12-months.
https://exactmacro.substack.com/p/stock-and-gdp-outlook-for-week-ending-616
Doing so produces more convincing estimates of the NGDP output gaps and actually supports the perspective you’ve had for years over that of my own, except for 2016 or so and early 2019. It has monetary policy being relatively very loose during the internet boom, sans the early 2000s recession, and very tight during the Great Recession and recovery. You can notice that it has the economy returning to equilibrium by late 2014, which is much more in-line with your claims over the years than mine. I had been pushing the question over whether the economy had returned to equilibrium at all.
It does also show that the economy was under-capacity in the first half of 2019, which can give me a minor victory, but the return to above-equilibrium growth by the end of that year is not something I’d have anticipated. You did acknowledge that it was possible the economy was slightly below equilibrium in 2019, but didn’t think the difference would matter much, as the economy was “booming” in your estimation. It was indeed booming in the second half of 2019 if you take this metric seriously.
So, I have to mostly concede years worth of arguments to you, as your strict adherence to fundamentals won out over me trying to clumsily out-guess them.
At least this may highlight that the stock market may indeed offer a lot of rather precise information at times, if we know how to interpret it. My thinking is that when NGDP growth exceeds the earnings yield, as it does now, if monetary policy begins to tighten in a soft landing scenario, we should expect convergence of these metrics from both sides. Hence, the expectations that the yield will rise to just over 5% over the next 6 quarters should be encouraging, and it would put the equilibrium nominal growth rate at somewhere around 5%, though that rate can obviously change.
31. March 2024 at 07:07
re: “You can notice that it has the economy returning to equilibrium by late 2014,”
That was due to the reversal in unlimited transaction deposit insurance in Dec. 2013.
re: “The central bank is the sole monopoly provider of the domestic economy’s money supply”
Yes, See: ANATOL B. BALBACH and DAVID H. RESLER: “Eurodollars and the U.S. Money Supply”
https://tradingeconomics.com/commodity/crb
Still too much froth.
31. March 2024 at 07:43
If you want a stable monetary system the answer is right in front of you, and it always has been.
1. Choose a commodity with a fixed supply like Bitcoin.
2. Declare “money” to be bitcoin and/or gold and/or any digital currency with a fixed supply.
3. End the Federal Reserve. Tell monetary economists to kindly seek other jobs. Like sweeping floors, or selling widgets.
If you want end the centralization of power the answer should be clear.
1. End the Federal Income Tax. Force the Federal government to collect taxes from VAT (like 2%.)
2. Pay the bulk of the tax to your community, where you live, and a small tax to the state.
It’s that simple. Nothing radical. All things we once had, but lost, when the Irvings, Keynesians, Friedmans and Sumners came along.
There used to be a global currency, accepted in every country. It was called gold.
31. March 2024 at 08:38
Michael, Thanks for that information.
Sara, Yes, the value of Bitcoin is certainly very stable!!
31. March 2024 at 08:57
They are hoping inflation will return to target with no more hikes.
Possible?
31. March 2024 at 09:38
@Sara: “If you want a stable monetary system the answer is right in front of you, and it always has been. 1. Choose a commodity with a fixed supply like Bitcoin.”
You don’t seem to realize this, but a fixed supply does not result in a fixed value. If the value of money is not stable, then the monetary system as a whole is not stable.
In a free market, the price of a good depends on BOTH supply and demand. The demand for money is not stable. Hence, if you fix the supply, then the value of money will also not be stable.
Supply and demand should be covered in an introductory Econ 101 class, if you’re interested.
1. April 2024 at 04:11
“Highly consequential” seems to be a reference not just to the technical aspects but to their present belief that interest rate decisions are invested with huge moral significance. I wonder if anyone has done a study on association of intensely moral language on the part of FOMC members and monetary policy mistakes. There are of course traders who stand to benefit from whichever way their decision goes, but it would seem very difficult to tease out which side should enjoy the benefit of “moral” considerations at any particular point in time. The Fed is not really a body that seems constituted so as to be competent to weigh complex moral questions.
1. April 2024 at 08:09
If NGDP growth remains high, the inflation will persist.
Yep and been my view since late last year that Fed would find it quite challenging to get inflation to its desired target. Most of my fixed income investment has thus been in money market accounts with some in short term treasuries. Plan on staying short until we really see rate cuts of which I am not holding my breath to see anytime soon.
1. April 2024 at 08:33
Bobster, Sure, it’s possible.
Jeff, Of course rates can fall due to either tighter or easier money. The “consequences” depend on which one applies. Never reason from a price change.
2. April 2024 at 00:27
Scott,
Thesis:
The Fed cares less about inflation (let alone NGDP) than it cares about the election cycle, asset prices or the funding of the deficit.
Disprove!
2. April 2024 at 08:06
To what do you attribute the economics profession desire to explain away inflation?
3. April 2024 at 03:48
Monetary policy ‘works’?
‘The fact is that five times in the last four years, DC has been doing QE by just another name (what I call “backdoor QE”) to avoid the embarrassment of direct QE.
Notwithstanding the “not-QE” (which really was QE) in 2019 when the Fed bailed out a cash-dry repo market (which, by design, no one understood), the DC magicians have been doing trillions worth of QE-like liquidity measures without having to call it, well QE…
That is, the Fed and Treasury Dept. have been pulling liquidity out of the drying Treasury General Account, the now retired “BTFP” measures, and the intentionally confusing reverse repo markets.
More recently (and equally as well intentionally confusing to the masses), the Fed is quietly on the verge of allowing the Fed banks to use unlimited leverage to buy unlimited amounts of USTs off the Fed’s balance sheet via the removal of what the fancy lads call “Supplementary Reserve Ratios.”
This latest trick, by the way, is just off-balance sheet QE, and yet another symptom of the big banks becoming branch offices of the Fed, as our centralized becomes even more grotesquely, well…centralized, which is a classic symptom of a desperate and debt-soaked regime.
But just in case none of the foregoing tricks of backdoor QE have convinced you of what basically amounts to just QE, we can get our clearest signals from—you guessed it: THE BOND MARKET.
That is, one of the most obvious examples of “backdoor QE” is the Treasury Department’s open yet ignored trick of issuing most of its recent debt from the short duration end of the yield curve.’?
https://vongreyerz.gold/the-implications-of-fatal-debt-expect-more-lies
4. April 2024 at 19:00
Effem, They have the wrong model, and look for excuses as to why it doesn’t work.
5. April 2024 at 15:20
Contrary to most economists, banks don’t lend deposits.
See: Banks Are Intermediaries of Loanable Funds | Cato Institute
No, deposits are the result of lending/investing. Those economists simply can’t see the forest through the trees.
See: Recent developments in bank deposits
https://fredblog.stlouisfed.org/2024/03/recent-developments-in-bank-deposits/?utm_medium=email&utm_campaign=202404%20Research%20Newsletter&utm_content=202404%20Research%20Newsletter+CID_f08590b383a14e53b8ab9ff10b084eec&utm_source=Research%20newsletter&utm_term=away%20from%20less-liquid%20savings
That’s the opposite trend of secular stagnation.