Market-implied NGDP expectations fell from 3.9% year-ahead before the recent Federal Reserve policy statement, to just above 3.8% after. A disappointing result and a stark way of quantifying the restrictiveness of current Fed policy.
The Fed had announced months ago that four rate hikes would be done in 2017, and yes, they really mean it. We think nominal income growth is the best single way to quantify what monetary policy is doing to the economy, but if you’d prefer the Fed’s Personal Consumption expenditures price index along with job growth, well then the message is the same: the economy is mediocre, job growth is slow, wage growth is terrible, inflation is systematically below the Fed’s target.
Our NGDP forecast’s response to the latest rate hike shows that the current policy of slowly raising rates is destined to fail. The Fed would presumably like to see the Fed Funds rate in the 3% to 5% interval, the way it was before 2007. To get rates that high, the Fed would first have to ‘start a fire’ or get the economy ‘really crankin’ to use the vulgate. This would be manifested by an NGDP growth expectation of 5% or 6%, not sub-4%. The Fed would then chase this relatively high nominal growth rate with a series of rate hikes, classic Alan Greenspan.
But instead, by raising rates while inflation has been systematically below target, while the labor market remains badly depressed, the Fed is signaling to markets that it’s not interested in kindling the sort of boom the economy could not only handle, but needs. The economy can run at the current outlook of 3.8% NGDP growth, but the real question is: what will the Fed do in 2018? Will they push for a Fed Funds rate of 2%? Will they back off if markets balk? Will they be willing to surrender the recent ‘gains’ in the Fed funds rate if banks suffer some hiccup and stop lending? No one knows and this is why markets are justifiably cautions.