Must-Read: Tim Duy: Is Pushing Unemployment Lower A Risky Strategy?

Must-Read: Tim Duy thinks, I believe correctly, that the Fed is confusing its own past policy errors with economic laws:

Tim Duy: Is Pushing Unemployment Lower A Risky Strategy?:

Fed hawks are pushing for a rate hike sooner than later in an effort to prevent the economy from “overhearing”…

…argued to set the stage for the next recession…. John Williams:

History teaches us that an economy that runs too hot for too long can generate imbalances, potentially leading to excessive inflation, asset market bubbles, and ultimately economic correction and recession. A gradual process of raising rates reduces the risks of such an outcome…. If we wait too long to remove monetary accommodation, we hazard allowing imbalances to grow, requiring us to play catch-up, and not leaving much room to maneuver. Not to mention, a sudden reversal of policy could be disruptive and slow the economy in unintended ways….

William Dudley….

A particular risk of late and fast is that the unemployment rate could significantly undershoot the level consistent with price stability. If this occurred, then inflation would likely rise above our objective. At that point, history shows it is very difficult to push the unemployment rate back up just a little bit in order to contain inflation pressures. Looking at the post-war period, whenever the unemployment rate has increased by more than 0.3 to 0.4 percentage points, the economy has always ended up in a full-blown recession…. This is an outcome to avoid….

I don’t know that there is a law of economics where the unemployment can never be nudged up a few fractions of a percentage point. But I do think there is a policy mechanism…. Rhe Fed tends to overemphasize the importance of lagging data such as inflation and wages and discount the lags in their own policy process. Essentially, the Fed ignores the warning signs of recession, ultimately over tightening…. For instance, an inverted yield curve traditionally indicates substantially tight monetary conditions. Yet even after the yield curve inverted at the end of January 2000, the Fed continued tightening through May of that year, adding an additional 100bp to the fed funds rate. The yield curve began to invert in January of 2006; the Fed added another 100bp of tightening in the first half of that year. This isn’t an economic mechanism…. This is a policy error….

Bottom Line: The Fed thinks the costs of undershooting their estimate of the natural rate of unemployment outweigh the benefits. I am skeptical they are doing the calculus right on this one. I would be more convinced they had it right if I sensed that placed greater weight on the possibility that they are too pessimistic about the natural rate. I would be more convinced if they were already at their inflation target. And I would be more convinced if their analysis of why tightening cycles end in recessions was a bit more introspective. Was it destiny or repeated policy error? But none of these things seem to be true.