Must-Read: FT: The Prevailing Case for Caution by Central Banks
Must-Read: There are two big questions for the Federal Reserve:
- Why, if you want to tighten monetary policy, are you doing so first by raising interest rates rather than by shrinking the balance sheet?
- Why are you so sure that your models predicting inflation rising above 2% in 2018 are superior to market expectations which see inflation as remaining below 2% into the next decade?
The first remains a mystery to me. Nobody has yet set out for me how the Federal Reserve views the relationship among its four tools of interest on reserves, the Federal Funds rate, the size of its balance sheet, and forward guidance.
I think the answer to the second is: The Fed does not think that its forecasts are superior, but does think that if inflation gets above 2% it will be unable to nudge it down without triggering a recession. This belief that attempts to nudge inflation down will fail has turned 2% from a target to a ceiling. And the FT is not a happy camper:
FT: The Prevailing Case for Caution by Central Banks: “The US Federal Reserve signalled a high likelihood that interest rates will be raised when it meets next in December…
…The markets took the Fed at its word…. The Fed’s enthusiasm for raising interest rates at all remains something of a puzzle. Growth in the real economy, both gross domestic product and the labour market, remains strong. But given the uncertainties of recent years, and historically low labour market participation in the US, the size of the output gap and the exact location of full employment are a mystery. The Fed’s preferred measure of inflation, the personal consumption expenditure deflator with energy and food prices stripped out, remains below the 2 per cent target, as do expectations of future inflation…. Across most advanced economies, the underlying picture is the same: inflation remains historically low and there are few signs of a sustained rise caused by excessive demand. Central banks should err on the side of keeping monetary policy loose.