The universal constant

Every few months after the FOMC Meeting, the Fed publishes the Summary of Economic Projections (SEP). An important component of the SEP is the long-run median of the FF rate, real growth rate, unemployment rate and inflation rate. Those are the rates the FOMC expects will prevail in the long run, or the rates towards which the economy will converge.

The charts compare the long-run median with the ongoing rates for those variables.

It´s notable that the rates expected to prevail over the long run have been systematically reduced. What is behind this one-way revision? Take, for example, the unemployment rate. Since the fall in the rate of unemployment has not driven inflation higher, as predicted by the Fed´s Phillips Curve view, the estimate of the long run (or natural) rate of unemployment has been lowered.

Note than when real GDP growth dropped below the long-run estimate (or potential), this rate was revised down. Now, the Fed says the economy is growing above “potential”, a “sign of strength”, signaling that inflation will converge to the 2% target.

Then there is the “universal constant” or the 2% inflation target. The core PCE rate better reflects the inflation trend, given that it “ignores” volatile components. The chart, in fact, suggests that 2% is not a symmetric target, but a ceiling!

With that, according to Joseph Gagnon, the Fed has bought into secular stagnation. The Fed doesn´t see that as the outcome of its policies. For example, with real growth above “potential”, the Fed believes it has to constrain growth further to avoid an undesirable rise in inflation…


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