The Fed´s “doom machine”

Tim Duy “terrorizes” in his “Fed will keep rate hikes coming”:

Lots of news from last week, most of which supported the Fed’s current anticipated rate path of one 25bp hike in December followed by three more in 2018.

The only potential obstacle on that path is the persistent weakness of inflation. But the ongoing decline in the unemployment rate, along with the promise of further declines in the months ahead, will dominate lingering concerns at the Fed regarding the inflation numbers.

That´s exactly Yellen´s thinking:

It’s important to try to estimate the unemployment rate that is equivalent to maximum employment because persistently operating below it pushes inflation higher, which brings me to our price stability mandate.

–Janet Yellen, January 18, 2017

When monetary policy is synonymous with interest rate policy, and when the rate of unemployment is the “guiding light” to interest rate decisions, what you get is very bad monetary policy.

Look at the charts below

While you do not see any obvious relation of unemployment and inflation, you see a clear relation between unemployment and nominal spending (NGDP) growth.

When spending growth falls off its path, unemployment increases and the magnitude of the unemployment increase depends on the magnitude of the spending fall.

A stable level of spending growth is consistent with unemployment falling, while inflation remains low and stable.

With inflation expectations anchored, drops in spending growth have little effect on inflation. The deep drop in spending in 2008-09 had some impact on inflation, but that was temporary because inflation expectations remained stable.

Meanwhile, the Federal Funds rate, set by the Fed has “travelled widely”.

In the shaded areas, the FF rate falls significantly. By that metric, monetary policy was “easy”. How can that be with spending growth falling and unemployment rising? Friedman´s dictum solves the puzzle. According to Friedman, “low interest rates are a sign that monetary policy has been tight”.

Bottom line: if the Fed is afraid of low unemployment, it should decrease the rate of spending growth. If it pursues that objective, it will end up with rising unemployment but inflation expectations (and inflation) would fall. The result would be a recession within a depression and the loss of Fed credibility!

PS: A new “Leading Indicator” of inflation – restaurants – has been suggested:

Menu Prices Will Tell the Future of Inflation – When wages rise, these businesses must raise prices or go bust.

If these price hikes materialize, they could be an early indication of inflation getting back on track: Restaurants are more sensitive to labor conditions to most, but all industries are eventually affected.

But, restaurants can also foretell recession:

If the margin pressures on restaurants leave them too cautious to raise prices, we’ll see a wave of restaurant closures and laid-off employees — another sign that the economy is stuck in a post-recession rut.


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