The behavior of the Federal Reserve remains a puzzle: Tim Duy: Set to stay on current path

The behavior of the Federal Reserve remains a puzzle. They seem to be reacting month-to-month, and to be happy with their current policy stance of gradual raising until and unless something goes wrong. They do not seem to be thinking down the game tree very far—not taking account of how their current policy stance exposes them to huge downside risks should low r-star continue, should “secular stagnation” be the correct diagnosis, and should there be any kind of significant adverse demand shock to the economy: Tim Duy: Set To Stay On Current Path: “When is the economy at or beyond full employment?…

..>Will inflation accelerate?… How much inflation overshooting will the Fed tolerate?… Growing downside risks? Although activity remains consistent with the Fed’s forecast, there is always a risk that the current tailwinds revert again to headwinds. Supply chain disruptions stemming from international trade disputes, for example…. There is growing evidence of decelerating global activity…. Streaks of good luck eventually come to an end.

Bottom Line: I anticipate the Fed will continue to hike interest rates… 25bp a quarter for the rest of the year and into next…. Considering the resilience of very long rates to policy tightening, I anticipate that further upward pressure on rates remains concentrated on the short-end of the yield curve. I suspect the Fed continues to hike rates until they flatten out the yield curve–at that point policy makers will face some more significant challenges.

May 12, 2018


Brad DeLong
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