Must-Read: Tim Duy: Fed Struggles with the High Water Mark

Must-Read: I continue to fail to understand the apparent thinking of the center of the Federal Reserve. The following argument seems to me to be obviously correct:

  1. Asymmetric risks and the strong desirability of not returning to the zero lower bound after interest-rate lift-off call for raising interest rates not early and slow but late and fast.
  2. That plus the strong desirability of making it clear by actions that show their consequences in the data 2%/year for the PCE chain index–2.4%/year for the core-CPI–is a target and not a ceiling means that optimal risk management is to wait until rising inflation is present in the data before beginning lift-off
  3. The risks of damaging credibility via error are much less if the policy is to delay lift-off until there are signs of rising inflation as opposed to lifting-off as soon as demand plus the shakily-estimated Phillips curve say rising inflation is coming.
  4. Committee harmony is lost, whether there are formal dissents in December or not.

Even if the center of the Federal Reserve has not internalized Staiger, Stock, and Watson and pretends that their estimated Phillips curve is is the eternal truth of The One Who Is–on the grounds that “you need a forecast to make policy”–interest rate increases in December make no sense, and interest rate increases in March make no sense unless core inflation starts trending up right now:

FRED Graph FRED St Louis Fed

Tim Duy: Fed Struggles with the High Water Mark: “If we get two more reports hovering around 200k a month [in employment growth]…

…between now and December, matched with generally consistent data across other indicators, then December is on the table…. If jobs growth slows to 100k a month… we are looking at deep into 2016 before any hike. Around 150k is the gray area…. I suspect that more numbers like the last two will make the December meeting much like September’s. That I fear is my current baseline–another close call in which the Fed concludes to take a pass.

Gavin Davies: Is the US slowdown for real?: “Several investment banks’ economics teams have ruled out a December rise…

…The expected federal funds rate at the end of 2016 implies only two Fed rate hikes in total over that entire period. Clearly, investors increasingly believe that the US economy is now slowing enough to throw the Fed off course. This big change in market opinion is, frankly, surprising. The rise of 142,000 in non-farm payrolls in September was not all that weak…. The US slowdown [is] for real… but it is not yet very severe…. Unless it grows worse in the next few weeks, it is unlikely to dislodge the Fed from the path it has now firmly chosen.

October 20, 2015


Brad DeLong
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