Must-Read: Ryan Avent: Expect the Worst

Must-Read: the sharp Ryan Avent, I think, nails it:

Ryan Avent: Expect the Worst: “It wouldn’t make sense for the Fed to target real GDP growth, but then, the Fed is not really in that business…

…The Fed is also unable to control the long-run real interest rate, which is a function of global saving and investment. What’s more, it does seem clear that the global real interest rate has settled down to a level of approximately zero. But does it follow that the Fed should then either 1) set a high nominal interest rate in order to achieve higher inflation, or 2) keep its interest rate low and accept low inflation? I don’t believe so…. It is not the case that the Fed is choosing low rates and inflation expectations are therefore converging toward a low level…. The Fed has been targeting very low inflation, and falling inflation expectations imply much lower interest rates in future. This dynamic is there back in 2013. In its projections the Fed indicates that rates will rise steadily, even as it projects that inflation will be extraordinarily low, just over 1% in 2013, converging, finally, toward 2% by the end of 2015. Essentially every set of Fed projections since then has shown the same thing. It allowed its QE programmes to end despite too-low inflation, and it raise its interest rate in December despite too-low inflation. The Fed has signalled very strongly that markets should expect inflation to remain at very low levels, indeed, below target. It would be shocking if inflation expectations hadn’t trended inevitably downward….

Is there a route out?… Where in the past the Fed has promised to raise rates even as inflation stays low, it could instead promise to keep them low no matter what, even if, and indeed until, inflation rises above the target. If the Fed wants higher nominal rates in a world of low real rates, it must cultivate higher inflation…. The Fed can choose whether nominal rates get stuck near zero or rise to a higher, safer level. Right now, unfortunately, it is steering the American economy firmly into a low-rate rut.

June 22, 2016


Brad DeLong
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