Tag: Tim Duy

Must-read: Tim Duy: “Fed Yet to Fully Embrace a New Policy Path”

Posted on by Brad DeLong

Must-Read: Tim Duy: Fed Yet to Fully Embrace a New Policy Path: “The Fed will take a pause on rate hikes. An indefinite pause…

…The sooner they admit this, the better off we will all be. Indeed, the sooner they admit this, the sooner financial markets will calm and the sooner they would be able to resume hiking rates. Federal Reserve Chair Janet Yellen had two high profile opportunities this week to make such an admission. Yet she failed to do so….

By the end of 2015, the economy was near full-employment…. A combination of factors would work in tandem to slow activity… higher dollar, higher inflation, higher wages, and higher short term interest rates (tighter monetary policy). How much monetary policy tightening is consistent with the new equilibrium depends on the evolution of the other prices. A reasonable baseline at the end of last year was that 100bp of tightening would be consistent with achieving full-employment. That was the Fed’s starting point as well….

A key factor in keeping the US economy on the rails is acknowledging that tightening financial conditions via the dollar obviates the need to tightening conditions via monetary policy…. But the Fed has yet to fully embrace this story. And that leaves them sounding relatively hawkish…. Yellen & Co. don’t need to emphasize the direction of rates. They just can’t stop themselves. Worse yet, they feel compelled to describe the level of future rates via the Summary of Economic Projections. A level entirely inconsistent with signals from bond markets, no less. They don’t really know what the terminal fed funds rate will be, so why keep pretending they do? The ‘dot plot’ does nothing more than project an overly-hawkish policy stance that leaves market participants persistently fearful a policy error is in the making. It is time to end the ‘dot plot.’ 

Must-read: Tim Duy: [Stan Fischer] “Resisting Change?”

Posted on by Brad DeLong

Must-Read: Two takeaways this morning from Stan Fischer, and from Tim Duy reading Stan Fischer:

  1. 1.4%-2% inflation “positive and broadly consistent with price stability” “not in another universe [from 2%]… not a negative number” is the new 2% inflation target.

  2. Because the Federal Reserve has no confidence in its ability to nudge the unemployment rate up to its long-run NAIRU level without overshooting and causing a recession, it must always attempt to glide down to the NAIRU from above–and must not follow policies that risk pushing unemployment below the NAIRU, whatever it really is:

Tim Duy and Friends: [Stan Fischer] Resisting Change?](https://twitter.com/TimDuy/status/694715619929780224): https://t.co/2g24mCkTzv

Lance Bachmeier: @kocherlakota009 @TimDuy: “Good post…

…SF/EG (inadvertently?) communicate that 1.5-2% inflation is ‘good enough’ for them.

NRKocherlakota: “@TimDuy Problem: if 2% is the true symmetric…

…target of policy, the FOMC needs a U-Turn, not just a pause: https://sites.google.com/site/kocherlakota009/home/policy/thoughts-on-policy/1-21-16

Tim Duy: “@kocherlakota009 So…

…I don’t really believe the target is symmetric. Need to prove it to me.

NRKocherlakota: “@TimDuy Yes, and I worry that public/markets…

…have your same (reasonable!) doubts. SF’s and EG’s remarks don’t help assuage those doubts.

Lance Bachmeier: “@kocherlakota009 @TimDuy The strange thing…

…is that they’re lowering the [inflation] target after we’ve learned 2% is too low already.

Lance Bachmeier: “@kocherlakota009 @TimDuy I’m not even sure 2% is a ceiling…

…they want to prevent inflation from [even] reaching 2%.

Tim Duy: Resisting Change?: “Stanley Fischer[‘s]… speech… was both illuminating and frustrating…. Although his confidence is fading… he is resisting change…. The first source of my frustration… [is that] his definition of ‘accommodative’ depends upon a specific idea of the neutral Fed Funds rates. From the subsequent discussion:

Well, I think we have to wait to see…. We expect…. somewhere around 3 ¼, 3, 3 ½ percent, which is on average a bit lower than in the past. But we’ll be data-dependent….

If you don’t know the longer-run rate, how can you know how accommodative policy is? If the longer-run rate is close to 2 percent, then policy is less accommodative than you think it is. The endgame of policy is the dual employment/price stability mandate, not a specific level of interest rates…. [That the] Fed’s forecasts… have been foiled by oil and the dollar… would suggest a slower or delayed pace of rate hikes, but more on that later. As for market volatility and external events:

In addition, increased concern about the global outlook, particularly the ongoing structural adjustments in China and the effects of the declines in the prices of oil and other commodities on commodity exporting nations, appeared early this year to have triggered volatility in global asset markets. At this point, it is difficult to judge the likely implications of this volatility. If these developments lead to a persistent tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years that have left little permanent imprint on the economy.

This is unimpressive…. The likely implications of the volatility are straightforward. The decline in longer term yields signals the Fed is likely to be lower for longer…. It seems that Fischer does not acknowledge the Fed’s role in minimizing the impact of similar bouts of volatility. They have responded by either easing via additional quantitative easing, or easing by delaying tightening…. When you fail to recognize your role, you set the stage for a policy error. They can’t use the logic that they should hike in March because past volatility had no impact on growth when that same volatility actually changed their behavior and thus the economic outcomes. I guess they can use that logic, but they shouldn’t. So is March on the table still?… I can tell a story where they push ahead on the labor data alone. Back to Fischer….

A persistent large overshoot of our employment mandate would risk an undesirable rise in inflation that might require a relatively abrupt policy tightening, which could inadvertently push the economy into recession. Monetary policy should aim to avoid such risks and keep the expansion on a sustainable track….

Policymakers fear that they cannot allow unemployment to drift far below the natural rate because they do not believe they could just nudge it back higher without causing a recession. They can only glide into a sustainable path from above… [thus] the Fed will resist holding rates steady…. Indeed, one voting member is already working hard to downplay recent events. Today’s speech by Kansas City Federal Reserve President Esther George:

While taking a signal from such volatility is warranted, monetary policy cannot respond to every blip in financial markets. Instead, a focus on economic fundamentals, such as labor markets and inflation, can help guard against monetary policy over- or under- reacting to swings in financial conditions. To a great extent, the recent bout of volatility is not all that unexpected, nor necessarily worrisome, given that the Fed’s low interest rate and bond- buying policies focused on boosting asset prices as a means of stimulating the real economy. As asset prices adjust to the shift in monetary policy, it is to be expected that the pricing of risk will realign to this different rate environment…. If we wait for the data to provide complete confirmation before making a policy decision, we may well have waited too long….

Watch for policymakers to downplay the inflation numbers as well. Back to George:

Finally, inflation has remained muted as a result of lower oil prices and the strong U.S. dollar…. Yet… core measures of inflation have recently risen on a year-over-year basis. And although inflation rates… have hovered below the Fed’s goal of 2 percent, they have been positive and broadly consistent with price stability.

Note the ‘positive and broadly consistent’ line. And Fischer:

And our view of progress is what the law calls maximum employment and what we call maximum sustainable employment, and a 2 percent inflation rate. And when we get there—we’re there—we’re very close to there on employment, and on inflation the core number that came out this morning was 1.4 percent. You know, that’s not 2 percent. It’s not in another universe. It’s not a negative number. But inflation’s been pretty stable, and we’d like it to go up.

Not in ‘another universe’ from 2 percent. Not negative. Sure we’d like it to go up, but are we really worried about it? Doesn’t sound like it to me.

Bottom Line…. I suspect market volatility and lack of inflation data keep them on hold in March and maybe April…. However (although not my baseline), I can tell a story where they feel like the employment data forces their hand. Especially so if they continue to downplay the inflation numbers. A substantial part of their policy still appears directed by a pre-conceived notion of ‘normal’ policy. This I think is the Fed’s largest error; the fact that the yield curve stubbornly resists being pushed higher suggests that the Fed’s estimates of the terminal fed funds rates is wildly optimistic. There appear to be limits to which the Fed can resist the global pull of zero (or lower) rates.

Must-read: Tim Duy: “FOMC Recap”

Posted on by Brad DeLong

Must-Read: Once again: if the economy comes in weak, then the FOMC will wish that it had not raised interest rates in December and will find it impossible to induce an offsetting deviation from the ex post interest rate path it will wish it had followed in order to balance things out. If the economy comes in strong, then the FOMC will wish that it had raised interest rates even earlier than December, but it will then find it easy to induce an offsetting deviation from the ex post interest rate path it will wish it had followed in order to balance things out. This ain’t rocket science. This is the simple logic of optionality near the zero lower bound and the liquidity trap.

So why does this logic evade the FOMC? What are they thinking?

Tim Duy: FOMC Recap: “Now they have slow GDP growth and fast employment growth…

…That will make brains explode on Constitution Ave. They don’t know what to do with that when unemployment is at 5%…. If the recessionistas are correct, then they already made a mistake in December. If the optimitistas are correct, they will fall behind the curve if they hold in March. And that is without the uncertainty of the financial markets. Did the Fed release a little steam by shifting into a tightening cycle, the avalanche control of Mark Dow?  Or did they set in motion the next financial crisis? And recognize that this is within the context of a no-win political situation….

So, considering all this, you can’t really blame the Fed for taking a pass on quantifying the balance of risks…. Bottom Line: The Fed got lucky this month. They weren’t expected to do anything, which takes the pressure off. But in March they might have a real decision to make. We have only six weeks of data to digest. Even assuming that labor markets hold solid, will that be enough? Doubtful. They will need more.

Must-read: Tim Duy: “On The Dispersion, Or Lack Thereof, of Economic Weakness”

Posted on by Brad DeLong

Must-Read: Tim Duy: On The Dispersion, Or Lack Thereof, of Economic Weakness: “I direct you to my fellow Oregon economist Josh Lehner…

…who correctly notes that in comparison to past recessions, the decline in manufacturing activity is not well-disbursed across the sector…. During a recession, the vast majority of manufacturing industries (or all!) are declining. We are nowhere near that point…. And if manufacturing is not even in recession, it is difficult to see that the US economy [as a whole] is in recession. Or even nearing it…. A recession in Texas does not a US recession make….

Aside from the recession risk, there is another important aspect of Davies’s chart–discounting manufacturing, it indicates growth of just 2% in the US…. I suspect that is the direction we will be heading by the end of the year if not sooner. Key sources of growth, such as autos, multifamily housing, and technology, that helped propel the economy closer to fully employment are likely leveling off. If so, that means the economy is at an inflection point as it transitions back to trend. The Fed expects that process will require addition tightening. The financial markets aren’t so confident.

Must-Read Pre-Liftoff Lollapalooza: Tim Duy: Makes You Wonder What The Fed Is Thinking

Posted on by Brad DeLong

Must-Read Pre-Liftoff Lollapalooza: The extremely-thoughtful Tim Duy is… genuinely frightened…

Tim Duy: Makes You Wonder What The Fed Is Thinking: “My interest tonight is a pair of Wall Street Journal articles that together call into question…

…the wisdom of the Fed’s expected decision… inflation, or lack thereof, by Josh  Zumbrun… the growing consensus among economists that the Fed faces the zero bound again in less than five years…. Fed officials expect the terminal fed funds rate in the 3.3-3.8 percent range (central tendency) while the 2001-03 easing was 5.5 percentage points and the 1990-92 easing was 5.0 percentage points. You see of course how the math works….

The policy risks are asymmetric. They can always raise rates, but the room to lower is limited by the zero bound. But that understates the asymmetry. You should also include the asymmetry of risks around the inflation forecast. The Fed has repeated under over-forecasted inflation. It seems like they should also see an asymmetry in the inflation forecast that compounds the policy response asymmetry. Asymmetries squared. Given all of these asymmetries, I would think the Fed should continue to stand pat until they understand better the inflation dynamics. The Fed thinks otherwise. Why would Federal Reserve Chair Janet Yellen allows the Fed to be pulled in such a direction? Partly to appease the Fed hawks. And then… Yellen is wedded to the theory that the sooner the Fed begins normalizing policy, the more likely the Fed can avoid a recession-inducing sharp rise in rates. She follows up this concern with: “Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.”

This is what Mark Dow calls ‘avalanche patrol’… becomes a story of a Fed caught between a world in which the policy necessary to meet their inflation target is inconsistent with financial stability…. And my sense is that Yellen feels the best way to slip through those cracks is early and gentle tightening….

The Fed likely only gets one chance to lift-off from the zero bound on a sustained basis…. They [sh]ould wait until they were absolutely sure inflation was coming. Even more so given the poor performance of their inflation forecasts. But the Fed thinks there is now more danger in waiting than moving. And so into the darkness we go.

Must-Read: Tim Duy: And That’s a Wrap

Posted on by Brad DeLong

Must-Read: The principal question the Federal Reserve should be discussing right now is: When the next adverse macro economic shock comes, the Fed needs to be in a position to cut the federal funds rate by up to 500 basis points. What should we be doing now to create an economy as fast as possible that is strong enough to allow for such a federal funds rate? Yet I am seeing no chatter around this question at all. Perhaps the silence is simply a consensus of despair?

Tim Duy: And That’s a Wrap: “The service sector number continues to bounce around a respectable range…

…A bit less so for… manufacturing…. The Fed is betting that a.) this data is noisy and b.) that the service sector is much, much more important to the economy than manufacturing and c.) some of the weakness in manufacturing will be alleviated as the oil/gas drilling and export drag soften over the next year in relative terms. Speaking of exports, the trade report came with a larger-than-expected deficit, a factor that added another hit to GDP nowcasting…. The Atlanta Federal Reserve Bank’s GDPnow indicator is currently tracking at 1.5%…. No fear, though… Janet Yellen… highlighted total real private domestic final purchases as the number to watch:

Growth this year has been held down by weak net exports…. By contrast, total real private domestic final purchases (PDFP)… has increased at an annual rate of 3 percent this year….

That sent everyone to FRED (the code is LB0000031Q020SBEA)…. When they search through the data for the happy numbers, you know they are looking to hike. Indeed, the clear takeaway from Yellen’s speech was that a rate hike was coming….

We are now well beyond the issue of the first rate hike. The new questions are how gradual will ‘gradual’ be and when will the Fed begin widening down the balance sheet…. Federal Reserve Governor Lyle Brainard argued to hold the balance sheet at current levels until interest rates are sufficient to provide a cushion for the next recession…. Brainard knows she has lost the battle to forestall the first rate hike further and has now chosen to stake out a position on one of the next big issues…. The pace of subsequent tightening, the normalization–or not–of the balance sheet, and the countdown to the next easing are all issues now on the table.

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

Posted on by Brad DeLong

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.

The Extremely-Sharp Tim Duy Sees the Fed Moving Away from Contractionary Policy

Posted on by Brad DeLong
FRED Graph FRED St Louis Fed

The extremely-sharp Tim Duy sees a much bigger potential impact than I do from Fed Governor Lael Brainard’s recent speech telegraphing future dissents on her part if the Federal Reserve raises interest rates in the current situation. Briefly, this: The failure to raise interest rates over the next nine months will call forth dissents from those whose analytical perspectives have been wrong pretty much all the time since 2007. Raising interest rates will call forth dissents from those whose analytical perspectives have been pretty much right all the time since 2007. Moreover, it is straightforward to undo the damage from being behind the curve in raising interest rates. It is impossible to undo the damage from being ahead of the curve in raising interest rates.

It would be one thing to raise interest rates if it were the unanimous consensus of the committee that it was time to do so. It is quite another, in a world of uncertainty and the need for prudent risk management. It’s quite another to risk making unrecoverable errors by endorsing those whose positions have been wrong in the past over the objections of those whose positions have been right.

Tim Duy: Brainard Drops A Policy Bomb: “Lael Brainard dropped a policy bomb…

…a direct challenge to Chair Janet Yellen and Vice Chair Stanley Fischer. Is was, as they say, a BFD. That, at least, is my opinion…. [She] stands in sharp contrast with Yellen and Fischer. Their efforts have been spent on explaining why rates need to rise soon. Hers… on why they do not…. Brainard asserts….

I do not view the improvement in the labor market as a sufficient statistic for judging the outlook for inflation. A variety of econometric estimates would suggest that the classic Phillips curve influence of resource utilization on inflation is, at best, very weak….

Recall that Yellen, in her most recent speech, made the Phillips Curve the primary basis for her case that rates will soon need to rise…. While Yellen sees the risks weighted toward rebounding inflation, Brainard sees the opposite. Moreover, policymakers have been twiddling their thumbs as the world economy turns against them:

Over the past 15 months, U.S. monetary policy deliberations have been taking place against a backdrop of progressively gloomier projections of global demand. The International Monetary Fund (IMF) has marked down 2015 emerging market and world growth repeatedly since April 2014.

While all of you have been arguing about when to raise rates, the case for raising rates has been falling apart!… [Brainard] calls for different risk management:

These risks matter more than usual because the ability to provide additional accommodation if downside risks materialize is, in practice, more constrained than the ability to remove accommodation more rapidly if upside risks materialize….

The Fed can’t cut rates quickly, but they can raise rates quickly…. Suppose that the Fed needs raise rates at twice the pace they currently anticipate.  What does that mean? 25bp at every meeting instead of every other meeting? Is that really an ‘abrupt tightening?’ Not sure that Yellen has a very strong argument here. Or one that would withstand repeated attacks from her peers…. I think Yellen wants to raise interest rates. I think Fischer wants to raise rates.  I think both believe the downward pressure on inflation due to labor market slack is minimal, and the Phillips Curve will soon assert itself. I think both do not find the risks as asymmetric as does Brainard…. I think that Brainard knows this. I think that this speech is a very deliberate action by Brainard to let Yellen and Fischer know that she will not got quietly into the night…. And now that Brainard has laid down the gauntlet, it will look very, very bad for Yellen and Fischer if their plans go sideways….

Brad DeLong suggested the Fed commit to one of two policy messages:

I must say that they are not doing too well at the clear-communication part. I want to see one of following things in Fed statements:

  1. We will begin raising interest rates in December at a pace of basis points per quarter, unless economic growth and inflation fall substantially short of our current forecast expectations.

  2. We will delay raising interest rates until we are confident that it will not be appropriate to return them to the zero lower bound after liftoff.

If we had one of these, we would know where we stand.

But Stan Fischer’s speech provides us with neither.

I think that Fischer wants the first option, but knows Brainard’s views, and hence knows that December is not a sure thing if Brainard can build momentum for her position. Hence the muddled message. Brainard could be the force that drives the Fed toward option number two… closer to that of Evans and… Kocherlakota…. This is the most exciting speech I have read in forever…

As a matter of economic reality, Brainard is correct: The lesson of Staiger, Stock, and Watson (1997) is that the Phillips Curve is much too imprecisely-estimated to weigh as more than a feather in the scales to reduce uncertainty about the state of the economy two years from now. The risks are asymmetric: The option to change course and quickly neutralize the effects of your past year’s policies is a very valuable one. Raising interest rates and starting a tightening cycle throws away that option. You can always raise interest rates quickly and further and undo the effects of being behind the curve in withdrawing monetary stimulus. You cannot lower interest rates below zero and undo the effects of premature tightening away from the zero lower bound.

As I have repeatedly said, the mystery is why the lessons of SSW and the asymmetry of the risks have not been the decisive arguments among the serious members of the FOMC all along.