The Fed makes-up reasons to justify their preferred actions

In her recent speech, Lael Brainard ends with the punchline:

In many respects, the macro environment today is the mirror image of the environment we confronted a couple of years ago. In the earlier period, strong headwinds sapped the momentum of the recovery and weighed down the path of policy. Today, with headwinds shifting to tailwinds, the reverse could hold true.

The charts indicate that there have been several instances of “mirror images” over the last 8 years.

The latest  “cycle” is characterized by the strongest headwind and the weakest tailwind.

That becomes more evident when you see that real consumption spending has not reacted at all to the “tailwind”.

No reason, therefore, to justify “hawkishness”.

She also says:

One of the striking features of the current recovery has been the absence of an acceleration in inflation as the unemployment rate has declined, a development that is consistent with a flat Phillips curve. Although wage gains have seen some recent improvements, they continue to fall short of the pace seen before the financial crisis.

However, we do not have extensive experience with an economy at very low unemployment rates and cannot be sure how it might evolve. In particular, we will want to remain attentive to the risk of financial imbalances.

The charts below show wage growth and inflation both for when unemployment is below (blue line) and above 5% (orange line).

Wage growth tends to be above average when unemployment falls below 5%. Inflation, however, “just doesn´t care”. What´s “remarkable” is that now, with unemployment far below 5%, wage growth is just as low, maybe even lower, than it was with unemployment over 5%! Inflation is no different.

The “innovation” in her speech, “justifying” a likely increase in the number of rate hikes, is that, even if low unemployment does not pull inflation, it might stoke “financial imbalances” (QED).


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