In July, monetary tightening bias reinforced

There were “pearls of wisdom”:

“We need to see the economy slow down a little bit … because I think eventually inflation pressures will emerge,” Williams tells reporters.

In his speech, San Francisco Fed president Williams also says:

The theme of my talk is that monetary policy is reaching its limit as to what it can do to generate economic growth. Other actors—in both the private and public sectors—need to step up and take the lead in making the investments and enacting policies needed to improve the longer-term prospects of our economy and society.

Which is the same story told by Board Member Stanley Fisher in a recent speech:

However, as I have said before–and Ben Bernanke before me–“Monetary policy is not a panacea.”19 Also, to repeat myself, policies to boost productivity growth and the longer-run potential of the economy are more likely to be found in effective fiscal and regulatory measures than in central bank actions.

Williams goes on to say:

Today, the U.S. economy is about as close to these goals as we’ve ever been. Among other things, we’ve fully recovered from the recession.

Which contarsts with the title of J W Mason´s paper published on July 25: “What Recovery? The Case for Continued Expansionary Policy at the Fed”, which concludes:

The question of how close the economy is to potential is one of the most important questions for macroeconomic policy today. We should not to take for granted that a low headline unemployment rate means that the economy has returned to full employment and full utilization of its productive capacity.

We must critically examine this claim, using the full range of evidence available. When this is done, we have suggested, it is much harder to sustain the view that the economy is close to potential than it appears at first glance. There is a strong case to be made that, a full decade after the financial crisis, the fundamental problem in our economy remains a lack of demand.

One problem is that, according to central bankers, inflation is generated by the gap between the demand for goods and services and the economy’s ability to supply them. As the economy grows and demand strengthens, that output gap should narrow and prices should rise.

However, that is not happening. For the G-7 countries, when we look at headline CPI published by the OECD, heavily influenced by the behavior of oil prices, we see that even when oil prices boomed at 80% year-on-year, headline inflation barely breached 2%.

Also according to the OECD, in June the year-on-year headline CPI for the G-20 countries, 2%, was the lowest since late 2009.

When Williams says that the economy has “fully recovered”, what he means is that the bar has been lowered enough to make actual output match the successively downgraded “potential output”.

That´s an interesting way to define “recovery”.

And since the economy is growing at a rate a bit above “potential”, he says “we need to see the economy slow down a bit”.

A new paper by Olivier Coibion, Yuriy Gorodnichenko, and Mauricio Ulate: The Cyclical Sensitivity in Estimates of Potential Output in fact shows that “potential” output estimates are worthless, in particular as a guide to monetary policy. According to their estimates of “potential” output, this alternative picture emerges:

But none of that matters, because according to Boston Fed president Eric Rosengren:

While the Fed’s preferred inflation gauge has shown price pressures have eased since March, Mr. Rosengren said he was more focused on longer-run trends in labor markets, which argue for continued rate increases, than on month-to-month inflation figures.

Which matches Yellen´s tongue-twisting answer to a question during her recent Congressional Testimony:

“We have quite a tight labor market and it continues to strengthen, and experience suggests that ultimately, although with a lag, we´ll see pressures on wages and prices. But we’re not seeing very substantial upward pressure on wages. But we may begin to see pressures on wages and prices as slack in the economy diminishes.”

This is very strange because even if we allow the output trend to have decreased after 2008, we are still far away from it. And this appears to have been a “job dump” non-recovery!

Recent data also indicates the Fed is on a tightening streak. However, to the Fed, the downtrend in the dollar index, long-term yields and spreads is indicative that “financial conditions” are easing, which justifies continuing monetary policy tightening, i.e. rate hikes. The fact that inflation expectations are also down is “irrelevant” to their mind-set!

That´s just the Fed making the “classical” error of “reasoning from a price change”.

The panel below provides a description of the stance of monetary policy over the last quarter century, as “measured” by the growth of NGDP relative to the “Great Moderation” trend. This makes clear the monetary nature of the Great Recession and ensuing “Long Depression”. It seems, however, that the Fed is not satisfied!


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