If growth is low, it’s always transitory

The FOMC Statement for May showed up some contradictions in Fed policy.

They have made it clear that they think the economy is growing modestly above trend. Hence, we still get rate rises, projections for more rate rises, plus the chatter about shrinking the balance sheet.

The Fed really do seem to be watching RGDP on an annualized QoQ growth basis, which is slightly insane when one is looking for trends. A YoY basis makes much more sense. However, who are the markets or we to question what the Fed looks at. They decide, and the markets and we have to follow them.

The slowdown seen in 2017Q1 to 0.7% on the QoQ basis was inconvenient but must have been broadly welcomed by the Fed. Back in 2016Q3 RGDP was growing at 3.5%. Too fast for the Fed. The breakneck speed was seen as a trend that had to be dealt with. It was also deemed by the Fed as a sign of the success of their supposedly highly accommodative or “ultra-loose” monetary policy, and showed that the Fed’s economic models were working. That QoQ grwoth rate justified the December rate rise.

It was a bit unfortunate that 2016Q4 RGDP slowed down to 2.1%. This was too quick a slowdown for the Fed to be able to “normalize” rates as fast as it wanted to. But at least if the Fed averaged the 3.5% with the  2.1% it could still claim the economy was growing modestly above trend and thus justify another rate hike. Hence the 25bps in March.

In the same vein of thinking, the super-slow 2017Q1 RGDP growth rate is way too soon to be a result of these hikes. The Fed (and consensus) model is one of long and variable lead times in the impact of rate movements. Thus, the 2017Q1 growth rate is officially deemed “transitory”.

The message is very clear, above 2% RGDP (on a quarterly basis) is a worry and needs to be dealt with, below 2% is an aberration. The world according to the Fed has to be like this or else it would imply that a mistake in the 50bps of rate rises since December – or that monetary policy really has never been highly accommodative at all.

The result of this strategy will be a constant pressure downwards in RGDP growth and thus more transitory misses than above trend naughtiness. Level targeting of RGDP would help prevent this madness. That will not happen, as it would elevate RGDP into too much of a formal target – which it should not be in any case. The Fed can, and should only target NGDP and leave RGDP in the long term to the people.

There will likely be no disaster thanks to the Dudley Put, but there will be precious little growth either.


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