The next five years

At the moment, monetary policy is boring.  But the next five years will be very interesting.  Take a look at this graph for the unemployment rate:

Screen Shot 2018-07-25 at 1.32.45 PMThere’s an interesting pattern there.  When the unemployment rate stops falling, we usually have a recession within about 18 months.

One exception is 1966.  During late 1966, it looked like we were entering a recession.  But the Fed put the pedal to the medal and we avoided a recession until the very end of 1969.

I feel fairly confident that the unemployment rate will stop falling within a couple of years.  I doubt it can go below 3%.  If so, we will enter a dangerous period for the economy.  The Fed will try to engineer a “soft landing”, but so far it’s had little luck. (And even if I’m wrong and unemployment falls to 2.5%, it merely puts off the day of reckoning by a year or so.)

In 1967, the Fed got so nervous that they pulled up on the steering wheel and never landed at all, soaring off into the Great Inflation of 1966-81.  In more recent cases we’ve had a hard landing into recession.

So is a low inflation soft landing impossible?  No.  The UK achieved a soft landing in 2001, and Australia hasn’t had a recession since 1991.  While a forecaster looking only at US data might say that a recession is extremely likely within the next 5 years, in my view the odds are closer to 50-50.

[Yes, that’s a wimpy forecast, where I can’t be “wrong”.  But that’s not the point of this post.  I make no claims to be able to forecast recessions.]

Past data is extremely misleading in macro, as the monetary regime is always evolving in response to previous mistakes.  The interwar period was not useful for predicting the postwar period, and the Great Inflation was not useful in predicting the Great Moderation, and the Great Moderation was not useful in predicting the Great Recession.  Subtle changes are always occurring.  Look how the business cycle has started stretching out since the 1950s.

Either of these two outcomes will be great for market monetarism:

1. If a recession occurs we can say, “See, we told you not to let NGDP growth plunge.  We told you inflation targeting was not reliable.”

2. If no recession occurs we can say, “See, we told you that if you keep NGDP growing at a steady rate you could moderate the business cycle.”

Of course if a recession occurs despite stable NGDP growth, then we’re screwed.

(BTW, David Beckworth has a new article in The Hill, on the prospects for Jay Powell adopting a monetary rule.)

Yes, it’s delusional to think our tiny band of MMs will get credit for a 14-year expansion.  Who would get (or “take”) credit?  I’m not quite sure . . .

Screen Shot 2018-07-25 at 2.20.42 PM

PS.  Read this hilarious article about what happened when Melania was caught watching CNN.  This is just 18 months in; imagine how wild things will be after another 6 years!



18 Responses to “The next five years”

  1. Gravatar of Benny Lava Benny Lava
    25. July 2018 at 11:49

    With tariffs raising costs I wonder if this will cause consumers to wait on purchases. What would that do for GDP? I am thinking of what happened to Japan after the housing collapse and banking crisis in the 90s.

  2. Gravatar of Andrew Andrew
    25. July 2018 at 11:51

    Just to add a bit of data to your post, there has never been a 0.3% rise in the unemployment rate without a recession following. There is a very fine line that they will have to walk to engineer a soft landing. Perhaps Hypermind and the new Augur contract will show them the way.

  3. Gravatar of ssumner ssumner
    25. July 2018 at 12:14

    Benny, It could have an impact, but as yet I don’t see that as a big factor.

    Andrew, The threshold is a bit more than 0.3% (look at 1986, or 1967), but your basic point is correct.

    As far as the “fine line”, this will be much easier to walk with a new policy regime.

  4. Gravatar of Becky Hargrove Becky Hargrove
    25. July 2018 at 12:17

    I don’t think market monetarists would be held accountable, should a recession occur with stable NGDP growth. More likely would be the ways in which structural supply side factors currently impact demand for overall monetary representation.

  5. Gravatar of bill bill
    25. July 2018 at 14:15

    Will tariffs be counted differently in PCE inflation vs the GDP deflator in ways that matter to MM or the Fed?

  6. Gravatar of Inklet Inklet
    25. July 2018 at 15:21

    Isn’t a recession generally defined in terms of NGDP?

    How would you especifically know you’re in a recession in an environment of stable NGDP growth?

    RGDP growth? a surge in unemployment?

  7. Gravatar of Christian List Christian List
    25. July 2018 at 17:05

    Past data is extremely misleading in macro

    I understand that. The same rule of thumb might apply to history in general. But shouldn’t this rule apply to financial investments as well (like your recent NASDAQ example) And if not, why not? Why in the world would financial investments be an exception?

  8. Gravatar of ssumner ssumner
    25. July 2018 at 17:07

    Becky, Perhaps if the supply shock was extremely large and obvious. But to be honest I think that’s unlikely. Absent something really weird and extreme, I’d view a non-falling NGDP growth recession as a problem for MM.

    Maybe a giant trade war? But that’s unlikely.

    Bill, Good point. I’d think that tariffs would be in PCE but not the deflator, but am not certain.

    Inklet, No, in terms of RGDP.

  9. Gravatar of Christian List Christian List
    25. July 2018 at 17:07

    Sorry for typos and so on.

    Past data is extremely misleading in macro…

    I understand that. The same rule of thumb might apply to history in general. But shouldn’t this rule apply to financial investments as well (like your recent NASDAQ example) And if not, why not? Why in the world would financial investments be an exception?

  10. Gravatar of Benjamin Cole Benjamin Cole
    25. July 2018 at 17:14

    Australia has gone a good while without a recession.

    According to this chart, China has not had a recession since 1960 or possibly before:

    What does the People’s Bank of China do right?

  11. Gravatar of E. Harding E. Harding
    25. July 2018 at 19:44

    @Benjamin Cole

    China’s official data suffers from a whole host of problems:

    China’s last recession happened around the time of the Tienanmen Square protests.

  12. Gravatar of LK Beland LK Beland
    26. July 2018 at 06:18

    A thought about how “this time is different”:

    During this cycle, fiscal policy was pretty tight during the first part of the recovery–e.g. the massive federal deficit decrease during 2013. Monetary policy had to be relatively vigorous to offset and keep NGDP on a +/- 4% growth trajectory.

    But slightly before reaching “maximum employment”, fiscal policy suddenly became very expansionary, essentially because the GOP won the Presidency, the Senate and the House (and the Supreme Court). Still, monetary offset seems to be about right and NGDP growth is barely above its post-2009 trend.

    This might provide an opportunity for a “soft-landing”: a fiscal tightening in the next few years–perhaps due to the Dems and the GOP sharing power after the 2018 or 2020 elections–might help the Fed reach its objectives.

    BTW, I understand that in principle, the Fed could completely offset fiscal policy if it used the proper monetary regime (say NGDPLT, or inflation level targeting). In reality, however, the Fed doesn’t consistently act in a way that offsets fiscal policy. Thus, “this time could be different”.

  13. Gravatar of Majromax Majromax
    26. July 2018 at 06:47

    I don’t think a ‘soft landing’ based on fiscal tightening is a reasonable prospect. As an example of a time when just such a landing was achieved, look at Canada in the 1990s: the government there successfully balanced the budget beginning from a peak deficit of 4.5%GDP.

    However, this was generally possible because the Bank of Canada simultaneously offered active monetary accommodation. The period began with a relatively weak national economy and high nominal interest rates (from the inflationary 80s), so there was both plenty of room above the ZLB and no psychological barrier against accommodation.

    In some ways the Fed would have an easier job in the face of fiscal tightening: it could possibly accommodate by holding rates constant. However, right now there’s strong institutional resistance to doing this.

  14. Gravatar of Justin Justin
    26. July 2018 at 07:18

    Recessions follow a brief flat-lining of the unemployment rate because a flat-lining in the unemployment rate is associated with a big drop in the NGDP growth rate (in the last 50 years). We have no idea how low the unemployment rate could have gone.

    As you say in the post, Scott, the regime at the Fed is non-stationary, I’d add that it’s totally opaque too, though I’m sure the Fed would never deliberately cause a recession because that wouldn’t maximize global consumer utility, which is what all policy makers care about.

  15. Gravatar of Christian List Christian List
    26. July 2018 at 11:31

    Let’s make things easy:

    If the economy remains strong, it’s because of The Donald.

    If the economy tanks, it’s because of MMs like Scott. =)

    I bet the economy is going to tank (in the next 2 years). And if we are lucky enough because of something Scott did not expect at all. China for example. China as cause would be really ironic. Or maybe Turkey. Is Turkey big enough already?

  16. Gravatar of Brian Donohue Brian Donohue
    26. July 2018 at 11:37

    Labor market demographics were WAY different in 1966. The bulge queuing up at the front end in 1966 is now effecting their egress. Also, hand-wringing over the prospect of 2.5% unemployment is funny. Maybe worrisome for “the economy”, less so for the actual human beings taking part.

    Slow recovery = long recovery. Are there ANY signs of an overheating economy?

  17. Gravatar of ssumner ssumner
    26. July 2018 at 11:48

    Christian, Yes, it also applies to the financial markets.

    Not sure if your second comment is supposed to be a joke . . .

  18. Gravatar of Matthew McOsker Matthew McOsker
    26. July 2018 at 15:32

    Brian i agree with you. I find NAIRU troublesome, because there is plenty of foreign labor that can be leveraged these days.

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