What have they done?

A frequent argument made by FOMC participants is that the Fed cannot wait too long to raise rates because that would increase the chances that the economy would “overheat”, pushing inflation above target.

Two examples:

Yellen (2015)

If the FOMC were to delay the start of the policy normalization process for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession.

Rosengren (2017)

Given the hot job market, “appropriate risk mitigation would argue for continued gradual removal of monetary accommodation, even though we are currently below the inflation target.”

Mr. Rosengren noted it was possible the jobless rate could fall below 4% and if it did, it would only increase the risk of economic overheating. Allowing that sort of jobless rate “would be a risk that would be unwise to take.”

Things are, in fact, quite the opposite. Over the past 10 years, the economy has “overcooled” and, given the Fed´s worry with “overheating”, it keeps “cooling down”.

To have a sense of where we´ve been and where we are, I look at the 10-yr average growth rate of per capita RGDP since 1880. The 10-yr average smooths out short run quirks in the data.

From 1880 to 2005, RGDP-PC growth averaged 2.2%, with a standard deviation (st dev) of 1.7. The st dev provides a measure of the variability, or volatility of the series.

Note that the 1880 – 2005 period encompasses several “crises”. For example, WWI, Great Depression, WWII, several recessions, some deep. Breaking the period up:

1880 – 1928 (to ‘avoid’ the Great Depression) growth averaged 1.8% with st dev of 1.1

1954 – 2005 (skipping WWII, the immediate aftermath and Korean War) growth averaged 2.1% with st dev of 0.6.

1984 – 2005 (the Great moderation) growth averaged 2.2% with st dev of 0.2

Note that during the sub periods, average growth was never far from the average for the whole period. Note also, how the volatility of growth fell over time, becoming very low during the Great Moderation.

Now, when we look at the last 10 years (2006 – 2016), we´re in for a big surprise.

2006 – 2016 (Great Recession + “Long Depression”) growth averaged 1.1%, or only half of the 125-yr average with st dev of 0.6.

The chart gives a poignant testimony.


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