Bad Monetary Policy: small effect on inflation, strong impact on real growth

Some love to “data mine” for inflation. David Rosenberg, for example, twitted:

Shh…don’t tell the Fed that its beloved core PCE deflator is running at 2.3% SAAR over the past 6 months (hottest in 7 years) and that the 3-month trend has shot up 2.8% — we haven’t seen this since Nov 2007. Yet another in the long list of late-cycle indicators.

The fact is that for the last quarter century inflation has been tame and contained, early or late cycle.

The panel below illustrates the implications of a bad monetary policy, here taken to mean a lower than ideal level and low growth rate of NGDP.

The effect on inflation is minor (from averaging 1.9% before crisis to 1.6% over last 7 years), while the impact on real output growth (RGDP) is significant, with output growth averaging 2.1% over last 7 years, compared to 3.2% before the crisis. Things are even worse when you take into account the fact that the level of real output fell markedly in 2008/09.

The “bottom line” is that you cannot have inflation on a rising trend if NGDP growth is stable, with the level of the stable growth rate being more significant to real growth than to inflation.

One implication: the bond rally ain´t over.


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