The market and the Fed

Stephen Williamson recently made this observation:

As a side note, I thought the part of the FOMC discussion where the staff gives a presentation relating to an alternative indicator – the difference between the current fed funds rate and what the market thinks the future fed funds rate will be – was good for a chuckle. If the FOMC thinks the market knows more about what it’s going to do than what it knows about what it’s going to do, we’re all in trouble.

I have the opposite perspective; we are in big trouble if the FOMC thinks it knows more than the market about what it will do to rates in the future.

Back in late 2015, the Fed began raising their target interest rate.  At the time, they anticipated another 4 rate increases in 2016.  Markets were skeptical, expecting only about one rate increase in 2016.  In fact, rates were not raised again until the very end of 2016.  That’s because economic growth and inflation during 2016 were below Fed expectations.  The markets were correct on this occasion (not always).

If you want an efficient estimate of the future path of interest rates, look at the market forecast, not the “dot plot”.  The dot plots are primarily useful as a measure of how deluded FOMC members are in their appraisal of the economy.  Because they were too optimistic in late 2015, they set rates too high.  That slowed the recovery, and probably tilted the (very close) election toward Trump.  And now, to quote Williamson, “we’re all in trouble”.

Interest rates are now higher than in 2016, but monetary policy is actually more expansionary than two years ago.  To Williamson’s credit, he is one of the few economists who seems to understand how this can be possible.

HT:  Tyler Cowen.



14 Responses to “The market and the Fed”

  1. Gravatar of Brian Donohue Brian Donohue
    10. July 2018 at 13:05

    I understand conceptually how this can be true, but that doesn’t mean it is. Lars thinks the Fed has become more hawkish recently, and that more hikes this year are probably a mistake.

  2. Gravatar of Michael Sandifer Michael Sandifer
    10. July 2018 at 16:17


    Yes, what makes you think policy’s expansionary enough right now? You don’t put much, if any weight on inflation. Most market monetarists on Twitter seem to be concerned about the flattening yield curve, as is James Bullard. Many are concerned that the Fed may be setting the occasion for a recession a year or more from now.

  3. Gravatar of Benjamin Cole Benjamin Cole
    10. July 2018 at 17:43

    Interest rates are now higher than in 2016, but monetary policy is actually more expansionary than two years ago. To Williamson’s credit, he is one of the few economists who seems to understand how this can be possible.—Scott Sumner

    I am not a credentialed economist, but I agree with the above paragraph. In fact, it appears to be a rather basic observation of an economy and monetary policy.

    But what does the above paragraph say about credentialed economists? Can we really compare economists to competent practitioners of hard sciences?

    Or even good plumbers?

  4. Gravatar of ssumner ssumner
    10. July 2018 at 20:54

    Brian, In this post I didn’t take any position on whether money is too loose or too tight.

    Michael, I put more weight on NGDP futures prices, which show a pretty strong 4.4% growth rate. (That’s above the current long term trend.) That doesn’t mean we can’t have a recession next year, but I trust the markets more than bloggers. And for those who don’t like NGDP futures, the stock market is also extremely strong, despite recent trade friction, etc. That suggests stock investors do not expect a recession.

    I’m actually a bit more worried about overheating and higher inflation–which then leads to monetary tightening and a sharp slowdown later on. I suspect that’s why the curve is flattening.

  5. Gravatar of Michael Sandifer Michael Sandifer
    11. July 2018 at 00:47


    It seems a problem though that the relevant NGDP futures contract only goes out through Q1 of next year. Sure, we might expect slower growth right now if markets thought a recession was a year or so away, but as you mention, growth is currently above the expected long-term future trend, hence not expected to last.

    Also, are you saying the stock market is extremely strong, just because it’s managed to stay positive for the year so far, despite the beginning of possible trade wars? The market’s only up around 4% this year with higher volatility since late January, and S&P futures are indicating a down start to tomorrow. The market’s spent roughly a quarter of the YTD in negative territory.

    That said, unemployment numbers don’t lie and, to me, they’re the strongest evidence that the economy is not particuarly awful right now.

    I’m concerned about the all too eerie flattening yield curve that has so often preceded acute episodes of tight money. I also agree that increased inflation due to tariffs or some other real shock could trigger unwise tightening by the Fed. My guess is a recession next year is somewhat more likely than in the average year, which means it could still be pretty unlikely.

  6. Gravatar of Fred Fred
    11. July 2018 at 05:51

    Williamson seems to be falling into the trap of thinking that the Fed ‘sets’ interest rates, or that FFR futures reflect ‘what the Fed will do’ versus ‘what economic conditions warrant.’ The only real discrepancy is that the FOMC might read the data somewhat differently depending on the composition of the voting committee, but the convergence to the mean (or the median, if you’d prefer) is so significant that the distinctions are likely quite small.

    I found more troubling from his piece the outright dismissal that the flattening yield curve could pose a threat — which is actually consistent with the idea that financial-market ‘pessimism’ is a function of expectations of declining future economic outcomes: it actually completely comports with FFR futures prices.

    (It’s also an ongoing phenomenon as the Fed has lifted the short end and was projected to lift it more, per a speech from a while back from Jim Bullard: not purely a more recent issue where only the long end was trending down. I’m shocked Williamson would dismiss this, but my faith in him has declined after reading his recent response to George Selgin.)

    Anyway, the trade war is really the only thing that immediately comes to mind that could materially shift long rates in a pessimistic direction, but the possibility of the Fed tightening a bit too fast, per the historical precedent, also looms in the background. Powell, correctly I think, shut this down recently, but the long end didn’t shift up, so maybe my interpretation here is off and it really is a term-premia world.

  7. Gravatar of Meets Meets
    11. July 2018 at 07:45

    Scott, do you agree the yield curve doesn’t signal recessions?

    Both Tyler and Williamson have made this argument

  8. Gravatar of Scott Sumner Scott Sumner
    11. July 2018 at 09:52

    Michael, The economy has lots of problems right now—monetary policy is not one of them.

    Fred, There’s always a risk of the Fed tightening too fast. But also keep in mind that these episodes typically follow periods where they did not tighten fast enough. The best way to extend the expansion is to avoid overheating.

    Meets, I’m not sure that’s exactly what they said. Here’s what I believe.

    1. The yield spread is a better forecast tool than most other variables. I doubt anyone disagrees with that claim.

    2. There are better forecasting tools than the yield spread.

    3. For those who like to use the yield spread, it does not currently forecast a recession. It is currently forecasting slower growth, which is not at all surprising given that recent growth has been above trend. Indeed slower growth may be appropriate, given that unemployment has fallen from 10% to 3.9%. Does anyone think it will fall another 6.1%?

  9. Gravatar of Michael Sandifer Michael Sandifer
    11. July 2018 at 19:24


    My discussion above is really about whether monetary policy is expected to get tighter. I can’t get past the notion that it’s remained tight since before the Great Recession, because the low productivity numbers bother me. Yes, US productivity growth began declning in 2004, but the average since the recession is lower and the numbers are since more volatile. The numbers tend to get volatile around recessions.

    I will not be surprised if there’s some measurement error, some J-curve phonemena, some shifting to service sector work, etc. that can explain some of it. But, productivity growth charts from some European countries and Japan much more strongly indicate a possible connection with tight money since the Great Recession. I just don’t accept that these are coincidences.

    Also, I think it’s possible money’s been too tight in the US since 2000. I don’t think the Fed kept up with the falling natural rate. I recall reading in Greenspan’s Age of Turbulence how shocked he was to be facing deflation fears in the early 2000s and how the yield curve wasn’t responding to policy as he expected.

  10. Gravatar of Michael Salvatori Michael Salvatori
    12. July 2018 at 03:59

    These posts are such garbage. It is amazing to me how incredibly ignorant academics are. They sit in the stands, while we are in the game, observe, then try to give us advice about playing. Let me ask you an obvious question: Would you rather have a former/current player teaching you the game, making observations about the game, recommending improvements, or would you prefer someone who has never played to teach you? If you choose the latter, I suppose we can remove belichek and choose plumber joe to lead the team. This is the disconnect that exists. And its very real. I challenge Scott to start a business. Go out there, take a risk, and provide a product or a service that provides value to others, then you might see trumps point of view. Scott loves free trade. He will show you mathematical models to support it, and tell you how wonderful it is. And he is right. Free trade is great. But we dont have free trade. We have never had free trade. And we never will. Take a vacarion to Shanghai, Beijing, Bangkok, Seoul, etc and compare their infastructure to ours. And then ask yourself, what happened? The idealism is blinding peoples ability to think clearly and logically. We dont live in a world where people are good. People are bad. And they will destroy you. This is why nixon sent aid to countries that “did something for us”. Not aid because we “feel bad”. And on top of the difficulty in competing, creating value, etc, businesses are extorted by politiicans, political insiders, etc, etc. When you have a company that earns 10M a year or more come to talk to me. Because you will understand for the first time the level of corruption. The world doesnt exist in the beautifully written pages of political economy text books. Do your research! Models are great. But models dont tell the whole story. You talk about students being lazy. You talk about students “hoping to pass with the curve”. Where is your effort to understand the nature of the game. Get in the game….do your homework. And you will see how unfair and rigged it can be.

  11. Gravatar of ssumner ssumner
    12. July 2018 at 10:29

    Michael S, Again, monetary policy affects employment, there’s very little evidence that it affects productivity. For instance, productivity growth was very strong during the 1930s.

    The other Micheal S, First, take a deep breath.

    You said:

    “Go out there, take a risk, and provide a product or a service that provides value to others, then you might see trumps point of view.”

    You mean like Trump University? Yes, I think I understand the point of view of a professional con man.

    BTW, I’ve been in Bangkok, and I’ll take USA infrastructure any day of the week.

  12. Gravatar of Michael Sandifer Michael Sandifer
    12. July 2018 at 11:10


    Yes, your view on the lack of relationship between monetary policy and longer-term productivity growth is certainly the prevailing view. But, I think one must admit that tight money could, at least conceivably, lower investment, which could lower productivity growth.

    Thst said, the burden of evidence is certainly on me, and I’m analyzing data. This is actually, initially, a very complicated question, as some of these variables could have mutual influence. For example, tight money could lead to lower output, which could reduce population growth, ceteris paribus, but there are also secular factors that lower population growth, and hence, real GDP growth expectations.

    I personally don’t think it’s possible to initially draw a firm conclusion.

  13. Gravatar of Michael Salvatori Michael Salvatori
    12. July 2018 at 22:47

    There is great nobility in starting a business and failing. I suggest reading Theodore Roosevelts “man in the arena speach”. It amazes me how folks consistently point to bankruptcies, or failed ventures like steaks, but don’t mention the successes. First of all, declaring chapter 11 is a tool to negotiate with banks. Its widely used. Second of all, do you own a skyscraper in manhattan? How about a golf course in Miami? Did you know that Coca Cola sells fake mineral water? Do we talk about that? How about 7-Eleven paying bribe money for politicians to get better locations? Do we talk about this? No. Because the fact is, this is the way the world works. Its not so nice. There is nothing wrong with selling real-estate courses. If people are willing to pay 30k for it, then great. More money for him, and less for the idiots who bought the course. With that said, there are letters from individuals claiming the course benefited them, and there is also a difference between “running a company and “lending your name” to a company. Many people lend names and then regret it, because it was run poorly etc,etc. You are too nice. Too idealistic. No one plays by the rules, and thats why the models dont work.

  14. Gravatar of Michael Sandifer Michael Sandifer
    12. July 2018 at 23:13

    Michael Salvatori,

    Trump University was an outright scam. There is no defending that. A scam finding willing suckers doesn’t make it legitimate or morally correct. Trump settled a massive lawsuit in favor of the victims.

    Trump committed fraud, pure and simple. In a video message to potential students, Trump himself said he was providing hand-picked real estate experts to teach the classes. That was a lie. In reality, he had little to do with the classes, apart from licensing his name and producing fraudulent marketing materials.

    As far as his bankruptcies are concerned, yes, sometimes talented businessmen have businesses that go bust, but six of them, and he, himself, benefitting from a “workout” from banks to avoid personal bankruptcy? The record reveals a pattern of reckless borrowing and failure to control costs. He was effectively personally bankrupt due to personal guarantees backing some of those reckless loans. For many years since, he’s depended on funding from Russians, by the admission of the family himself.

    He claims he’s a “stable genius”, but Warren Buffett or Elon Musk he ain’t. He’s incompetent and corrupt.

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