Must-read: Ryan Avent: “The Fed Ruins Summer: America’s Central Bank Picks a Poor Time to Get Hawkish”

Must-Read: And agreement on my read of the Federal Reserve from the very sharp Ryan Avent. Nice to know that I am not crazy, or not that crazy…

Ryan Avent: The Fed Ruins Summer: America’s Central Bank Picks a Poor Time to Get Hawkish: “THE… Federal Reserve… ha[s] been desperate to hike rates, often…

…keen to begin hiking in September, but were put off when market volatility threatened to undermine the American recovery. In December they managed to get the first increase on the books, and committee members were feeling cocky as 2016 began; Stanley Fischer, the vice-chairman, proclaimed that it would be a four-hike year… and here we are in mid-May with just the one, December rise behind us. But the Fed… is ready to give higher rates another chance…. Every Fed official to wander within range of a microphone warned that more rate hikes might be coming sooner than many people anticipate. And yesterday the Fed published minutes from its April meeting which were revealing:

Most participants judged that if incoming data were consistent with economic growth picking up…then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June….

[But] worries about runaway inflation are based on a view of the relationship between inflation and unemployment that looks shakier by the day…. Global labour and product markets are glutted… a global glut of investable savings too…. The Fed does not have cause to try to push inflation down. Its preferred measure of inflation continues to run below the Fed’s 2% target, as it has for the last four years. Somehow the Fed seems not to worry about what effect that might have on its credibility. All that undershooting has depressed market-based measures of inflation expectations…. If the Fed’s goal is to hit the 2% target in expectation, or on average, or most of the time, or every once in a while, or ever again, it might consider holding off on another rate rise until the magical 2% figure is reached. You know, just to make sure it can be done.

But the single biggest, overwhelming, really important reason not to rush this is the asymmetry of risks facing the central bank. Actually, the Fed’s economic staff explains this well; from the minutes:

The risks to the forecast for real GDP were seen as tilted to the downside, reflecting the staff’s assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks. In addition, while there had been recent improvements in global financial and economic conditions, downside risks to the forecast from developments abroad, though smaller, remained. Consistent with the downside risk to aggregate demand, the staff viewed the risks to its outlook for the unemployment rate as skewed to the upside.

The Fed has unlimited room to raise interest rates…. It has almost no room to reduce rates…. Hiking now is a leap off a cliff in a fog; one could always wait and jump later once conditions are clearer, but having jumped blindly one cannot reverse course if the expected ledge isn’t where one thought it would be…

May 19, 2016


Brad DeLong
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