The Fed just made us even dumber
The Fed cut rates by only 0.25%, which looks like a mistake. Here’s why:
1. This will make it even more difficult to hit the 2% inflation target.
2. Because the tightening was associated with a cut in the target interest rate, many pundits will wrongly conclude that policy eased. When this move does nothing to boost inflation, these same pundits will wrongly conclude that monetary policy is ineffective.
Why they think a policy that pushed up the dollar in forex markets is “expansionary” is beyond my comprehension, but that’s the world we live in. Thus monetary policy discourse is set to become even dumber. A fifty basis point cut would have made the discourse slightly less dumb. The general rule is that when the Fed moves rates in the same direction as the equilibrium rate, but more slowly, the discourse gets dumber.
3. Congress is currently running the most expansionary fiscal policy in history (given peace and prosperity), and this move will lead to calls for an even more expansionary fiscal policy. More fiscal stimulus will not help, rather it will be offset by monetary policy.
4. Long-term bond yields fell, but not because policy was easier than anticipated. Just the opposite. Yields fell because policy was more contractionary than expected. I.e., the income and Fisher effects are driving long-term yields lower.
I may add something later, after the press conference.
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31. July 2019 at 11:07
Powell said that more cuts could be coming
31. July 2019 at 11:10
How much did you want them to cut? I thought an initial .25-.50 cut was ideal?
31. July 2019 at 11:22
They just gotta get Trump re-elected. Monetary and Fiscal focused like a laser
31. July 2019 at 11:37
Morgan,
Don’t worry, Trump will say exactly the “right” thing to encourage tighter money and continue to push equilibrium rates down via trade policy.
On the economy Trump has been the luckiest president since Clinton, I wonder why his election chances are so low?
31. July 2019 at 11:44
Cameron Trump is odds on to win. Do you want to bet some money? What kind fo odds will you give me?
31. July 2019 at 12:04
Morgan,
I actually bet against Biden’s conditional probability on predictit which implied he had 75% odds to win if nominated (its now 60%). I think the betting markets are correct now, implying Trump has a 45-55% chance to win.
My point is more that he has surprisingly low odds given the economy and it shows how weak a candidate he is if he needs more support from fiscal and monetary policy to win. I continue to hold the belief the republican party would be much better off without him… assuming that is even possible now.
31. July 2019 at 12:07
Powell said something to the effect that the natural interest rate was lower than had been previously estimated. Suggesting, at least in his mind, that this cut moves monetary policy to less tight, but not easy.
31. July 2019 at 12:17
Cameron doesn’t read real news, he reads fake news.
Economy is doing so well because all the establishment corruption is being expunged and barriers removed.
Other countries, like CHINA, are no longer getting away with looting the American taxpayer.
Trillion dollar slush funds associated with human trafficking and crimes against humanity have been stopped.
Biggest tax cuts ever.
Biggest pro business executive in the history of the white house.
It’s not luck, you just can’t admit Trump is smart.
31. July 2019 at 12:22
We’re in 2019.
106 years after the Fed was formed.
Blog author sees it isn’t working.
Glutton for punishment or psycho on stilts?
31. July 2019 at 12:23
I posted on wrong article—-the Fed always tightens in the end—it is its nature. He could not help himself—the guy who wrote the WSJ essay this morning must be happy—because they believed Powell and co. were being fooled by Trumps trade war outcomes(???)—hence we get a “Mid-cycle” correction(????) on the way to…….further tightening.
31. July 2019 at 12:30
“I think the betting markets are correct now, implying Trump has a 45-55% chance to win.”
What FAKE betting markets is that from?
The real betting markets has him as favorite by a light year
31. July 2019 at 12:39
He is seeing magical fairies in his eyes—what is his “symmetric” 2% inflation? ——-
They think they are easing—he played the Nick Rowe hand—backward
31. July 2019 at 12:43
I see we have a new idiot commenter that just came out of the woodwork. The supply of fools seems almost unlimited.
31. July 2019 at 13:04
Yes yes, I know going off the approved left wing fake news MKUltra narrative LOOKS like foolishness and idiocy.
Name calling doesn’t impact independent minds, not sure where you learned it did.
You’ve been duly trained and conditioned to value group think over independent thought.
I bet you still believe Trump colluded with Russia, or believed the fake news narrative he did.
“…the investigation did not establish that members of the Trump Campaign conspired or coordinated with the Russian government in its election interference activities” – Volume 1, page 2, Mueller Report.
Liberals like yourself can’t tolerate facts that go against your narrative. You go all apes#!t.
31. July 2019 at 13:13
It’s not a coincidence that you are pushing at this time the same ‘racist’ narrative just like CNN trained you to do, now that the Demokkkrat’s Russia Collusion hoax has fallen apart.
Trump isn’t racist. That narrative only started because he dared standing up to the real racists in the Demokkkrat party.
https://imgur.com/poG9AUl
https://imgur.com/To4epTW
https://imgur.com/kEozjwe
https://imgur.com/QUHqNGy
What happens when the ‘controlled’ are told to create a new false ‘racist’ narrative [disinformation campaign]?
Do the ‘SHEEP’ follow?
Think for yourself.
SEE truth.
31. July 2019 at 13:15
https://imgur.com/QUHqNGy
When the left machine didn’t see Trump as a threat to their control…
31. July 2019 at 13:16
Scott … Isn’t the issue here that 2% CPI is not necessary in the first place to have a smoothly functioning economy? As I see it, we only have a positive CPI target to prevent the sticky-wage problem at the zero bound (on wages). In recessions employers don’t want to cut wages so you have a sort of vortex in business activity (and by extension banking).
But during good times it’s not necessary because the zero bound on wages is not in play. This is why growth is strong despite CPI constantly undershooting the mark. And this is what is giving the Fed headaches, no?
31. July 2019 at 13:17
https://imgur.com/poG9AUl
Those who believe the fake news narrative that Trump is a racist, are ASLEEP.
31. July 2019 at 13:20
https://i.imgur.com/DUL0r0V.jpg
WHERE DID THE $18 BILLION GIVEN IN 2018 ALL GO?
Welcome to the Democrat party con!
31. July 2019 at 13:31
http://magaimg.net/img/8lrf.png
POTUS gets it!
31. July 2019 at 13:33
Kgaard, I’d prefer a NGDP target, but if the Fed is going to target inflation at 2%, then they need to hit the target, on average.
You said:
“This is why growth is strong despite CPI constantly undershooting the mark.”
Yes, the Phillips curve is unreliable, for many reasons.
31. July 2019 at 13:34
Jason, A 50 basis point cut would have been better.
31. July 2019 at 13:44
“The general rule is that when the Fed moves rates in the same direction as the equilibrium rate, but more slowly, the discourse gets dumber.”
“Long-term bond yields fell, but not because policy was easier than anticipated. Just the opposite. ”
Scott, I can see how this is usually true for the US as monetary superpower, but would it be true for smaller countries like Australia? The RBA recently unexpectedly reduced official interest rates twice (in June and July) following a downward revision to its internal estimate of the natural rate of unemployment. This did lead to a small fall in the AUD, but longer term rates fell and have continued to fall by even more than the US. Since the start of May, the Australian 10 yr yield has fallen from 1.8% to 1.2% while the US 10 yr has fallen from 2.5% to 2%. Any thoughts?
31. July 2019 at 13:47
Scott, if the Fed can hit its targets by moving interest rates, why are you so deadset against interest rate targeting?
31. July 2019 at 16:06
Paul, interest rates seem to be ambiguous. It seems that they are not a good stance of monetary policy. And in major crises, the system seems to fail because it reacts too late. Not to mention that zero or negative interest rates seem to be another limitation.
31. July 2019 at 18:37
Rajat, Even in the US, long rates are hard to predict. Sometimes they fall with monetary easing and sometimes they rise. It probably has to do with changes in the future expected path of policy.
As far as longer run changes, Australia may be more exposed to the global slowdown than is the US.
Paul, Start with the fact that interest rate targeting is like a steering wheel that usually works fine, but locks up when driving on twisty mountain roads with no guardrails. Interest rate targeting seems to work fine, except in deep slumps. But that’s when you most need effective monetary policy!
NGDP futures prices are a much more reliable target.
1. August 2019 at 04:02
“Congress is currently running the most expansionary fiscal policy in history (given peace and prosperity), and this move will lead to calls for an even more expansionary fiscal policy.” I should think, Scott, that this argument cuts both ways: that fiscal policy is itself highly expansionary should, other things equal, provide some warrant for a less expansionary M policy this time around.
I also am very troubled by your writing, “Kgaard, I’d prefer a NGDP target, but if the Fed is going to target inflation at 2%, then they need to hit the target, on average.” That same thinking, had you adopted it in 2008, would have caused you to defend the Fed’s rate settings then, no? Sauce for the goose…
I would like to see a defense of the 50 point option based on NGDP or related nominal spending data. In the absence of such, I’m inclined to think that the FOMC got it right.
1. August 2019 at 05:48
George,
YOY NGDP growth over the past year was 4.0%, down from 6.0% a year ago.
Other points:
The Fed is poised to fall short of its 2.0% PCE target for the eighth consecutive year, producing a cumulative 5.2% undershoot of its own price target during that period.
There are still maybe a million prime age workers that could re-enter the labor force.
The short end of the yield curve is screwed up, because very short-term rates are too high.
1. August 2019 at 09:51
Brian, I agree that the recent GDP numbers offer support for a cut, though I’m not convinced that they warrant a 50 point cut. I wish we had better forward estimates; the OECD forecast has expected GDP YonY growth at 4.4% — a little shy of ideal, perhaps (which I think is perhaps 4.5-5%), but hardly a crunch. In any event I prefer that these and other spending indicators be given more weight than the PCE numbers, which so far as I’m concerned are just not reliable indicators of the stance of policy.
1. August 2019 at 10:09
George, I agree that monetary policy should adjust to the current fiscal stimulus, and I believe it has done so. Even at current policy settings, we are very likely to run below 2% inflation.
As far as NGDP growth, I agree that the recent performance provides no basis at all for a rate cut, even a 0.25% rate cut. My preference for a 50 basis point cut is based on market indicators suggesting a rapid fall in the natural rate of interest. I do not believe that a 50 basis point cut in the target interest rate would effectively ease monetary policy, relative to where it was a year ago. Rather the Fed would merely be keeping up with the (falling) natural rate.
Because of the Fed’s dual mandate, it would not have been appropriate to aim for 2% inflation in 2008, and I did not favor them doing so. Again, I agree that the 2% inflation target is a bad idea, but I do think that if they are going to have this target then they should aim to hit the target, on average, in the long run. But not each year.
I should add that I’ve been happy with Fed policy in recent years, and view this as a minor miss.
1. August 2019 at 12:28
Thanks for the clarification, Scott. I’m glad to know I wasn’t missing something in having concluded, based on my belief in the desirability of basing monetary policy decisions on the goal of stabilizing nominal spending, and my understanding of statistics regarding the state of such spending, that a 25 point cut was somewhere between unnecessary and perfectly adequate.