I guess I'm in the "If it ain't broke, don't fix it" camp. I'm biased because I'm retired, love getting 5% money market rates, and do not have a mortgage. I certainly will not cry a river over real estate developers going bankrupt. They have made a fortune over the past several years, fueled by the low interest rates. If they are so leveraged they cannot function with the current rates, they probably deserve to go out of business. The biggest problem in our economy right now are home prices. Low mortgage rates will just cause another boom that will make home prices even higher, especially in popular locations. People focus too much on interest rates, and forget that the principal is what drives your mortgage payments.
I am not retired, but I agree- every time the Fed makes a move there are trade-offs, and lower interest rates are great for some, but not everyone. I too feel exactly as much concern for real estate developers that they would feel about any misfortunes it might cause me, and that’s not at all.
I couldn’t agree more, especially about housing. A healthy economy can sustain modest interest rates, that’s what we’re seeing now. A decade of ZIRP deeply messed up the economy, and we should be wary of going back to that.
I have a CD ladder going with my average rate at 5.1% every time one matures, I have been able to find higher rate for next one. Maybe that party will be over soon, but some of them go to 2028 at 5% or higher. Of course, all taxed at highest rate plus Obama care taxes, so the government collects more tax with higher rates to help offset the higher amount they pay to themselves on debt.
Workers shifted to more productive work during the pandemic. All-time record new-business formation occurred in 2020 and 2021. Fed policy aside, I give most of the credit to American citizens who met the pandemic challenge. Of course, Larry Summers said millions would need to lose jobs to reduce inflation. Summers also declared Bidenomics “the biggest economic policy in 50 years.”
I think when the history of this period is written, the coin-operated Congress missed a rare opportunity to take advantage of real interest rates at zero. Congress’ stupid, petty culture wars were more important because, as always, our elected leaders were laser-focused on raising PAC money for their re-election campaigns. American citizens are of secondary importance to the Congressional clown car.
The Fed will best be served when it ignore Trump. In fact, Trump fatigue will turn off more voters outside the Banana Republican base (maybe 30%, at best). Trump has ridden the Republican Party to three consecutive election-cycle losses, a strong trend the mainstream media likes to ignore because it doesn’t see advertising. The trend isn’t Trump’s and the mainstream media’s friend. Twenty million first-time Gen Z voters, let alone Gens X and Y will show Trump the door in November. Hundreds of anti-MAGA organizers are networking via Zoom. Trump gets beat by high single digits. He will start whining “this election is fixed” by mid-summer. His strategy is to bully and threatened with violence voters at the polling stations. It didn’t work last time. And it won’t work in 2024. Time to turn the page once again on the temporary aberration of Agent Orange.
The question is, why has it not ALREADY cut interest rates? And I'm afraid that it because the Fed does not want to surprize the market, to do something it has not already said it would do or allowed an expectation to develop. This is "forward guidance" at its worst.
The simple statement of why they ought to cut is that inflation is falling, therefore real rates are rising. If, in fact, current policy has achieved a kind of Goldilocks-ian just-rightness, then _you need to cut to maintain that policy_. Declining to cut rates is, in effect, tightening policy, raising the risk of causing an unnecessary recession.
Well put. I don't know what r*, the policy rate that is consistent with stable (= target ?/=real income maximizing ?) inflation rate is and I don't think we need to know in order to believe that 5.25% is not it for the reasons you say.
They don’t want to start cutting and then have to hike because inflation bottoms and never sustainably reaches 2 pct. Both the labor market and consumer spending were much stronger than expected in Q4. Seems to have continued into January. Wage inflation is concerning. Productivity numbers have been volatile and unreliable since Covid- actually almost all economic data (and seasonal adjustments) have been volatile and unreliable since Covid.
I personally think the economy is going to slow over the next quarter and maybe grow 1-1.5 pct this year. Even if I am wrong and the economy stays strong, the Fed should be able to cut in May based upon policy becoming too restrictive in real rate terms.
That is probably a good explanation, but I disagree that they OUGHT to be reluctant to move and then back-track if necessary (although that seems quite unlikely). The message should, "We do this month what we think best to achieve our target and next month we will do what we think best to achieve our target."
It is nice that we have our 2019 economy back, and we only needed to spend 10 trillion more and suffer an inflationary bout to get it (and 7 pct of GDP deficits and growing ad infinitum)!
This economy is nothing like the 1990s, however. Monetary policy doesn’t exist in a vacuum but interacts with fiscal policy, which is as far removed from 1990s as ever (barring a couple years in WW2), and the 90’s also saw helpful disinflation and productivity impulses from globalization and rapid growth in EM (which led to excess/over investment and the Asian crisis, the Russian crisis, the Latam crisis, the telecoms bubble and the dot com bubble). Globalization isn’t a driver of disinflation currently (except in renewables due to Chinese overproduction).
100pct agree with you that we will get a rate cut in May or June, however. The economics/research team (many of whom originally hired by the very political/partisan Yellen and promoted under Powell) has laid sensible groundwork for it. Inflation has fallen to around 2.5pct, which puts real Fed Funds rates close to 3 pct- much tighter than they were in 2022 and most of 2023. The Fed probably wants to stay somewhat restrictive until inflation is reliably at/below 2 pct (will be helped by falls in CPI from the lagging housing components in 2024) but there is a good argument that 3 pct real rates are overkill, even with our unprecedented and irresponsible budget deficits at full employment. I don’t think we can ever do back to zero real Fed funds (which is what some of the Fed models still consider equilibrium) at full employment given our fiscal deficits, but 100 or 200bp over CPI/PCE seems possible. The Fed should cut rates to 4.625 by year-end, and maybe we could see a 3-handle in 2025 if the economy grows at 1-2pct this year and next and inflation bottoms out at 2-2.5.
Possible flies in the ointment are
1) it doesn’t seem as though Fed tightening actually has much impact on inflation. Real Fed funds was still negative in 2022 and early 2023 as inflation was falling rapidly. In other words, inflation fell because we stopped handing out trillions in stimulus and consumption patterns rebalanced between services and goods, allowing time for supply constraints to normalize, not because monetary policy was restrictive (it was less accommodative certainly, than the reckless 2021-2022 mix, but not restrictive at all in the historical sense….until the past 6-8 months). We will get some economic softening because of the high real rates of the last 6 months? This is the best argument for Fed cuts soon.
2) while the payrolls number/establishment survey showed 700k jobs created over the past 2 months, the household survey showed 700k jobs were LOST over the last 2 months. A 1.4mm discrepancy over 2 months is huge.
On the one hand I see the huge two month payrolls gain but no real change in participation or the unemployment rate and I think this should give the Fed comfort- this is a sign that maybe the population is increasing (the 6 million illegals waved through have to show up sometime) and we can support bigger payrolls increases.
But then I notice the household survey shows something completely different. So you can’t take the household data (unemp and part. rates) as comfort for the payrolls data. The payrolls data on its own shows overheating (payrolls growth above workforce growth, with 0.6 mom wage gains). The household data shows a slowing labor market and a declining population over the past two months (which has to be wrong). In other words, the data should be assumed to be gibberish for now and we’ll need a couple more months to see where things really are.
But are current interest rates actually "high"? Current US interest rates are just average for post-WW2. Even the so-called "low" interest rates of the 90s were about the same as they are now. It's the decade of near zero interest rates since the Great Recession that's the outlier.
There is pretty strong evidence going back 700 years that interest rates decline. So averages of a few decades ago don't mean much. There is no stable long term average to reference.
The future is zero real interest rates. Sure, the GFC probably pushed us to 0 sooner than secular trends would have. So a slight rebound is understandable but current rates a higher than you'd expect given the 700 year trend of suprasecular declining rates.
For more see Schmelzing's research line this Bank of England paper. There were numerous popular write ups of it in 2020 when it was published you can Google as well.
Good question. They seem high for the post GFC lost decade.
Are they high for a government (federal and state) running 7pc of GDP deficits at full employment? With globalization trends slowing?
Nobody knows. This is new territory.
Certainly doesn’t seem as if Fed policy since 2022 has been a driver of disinflation- that mostly happened on its own (H2 2022) while Fed policy was still accommodative by any historical standard.
Here is the link to a chart of real Fed funds over time
At some point your non-economist readers (cough cough) might benefit from a further discussion of Federal Reserve interest rate and liquidity levers, and its interaction with Treasury Department policy.
Even though inflationary expectations are low (as demonstrated by the inverted yield curve), doesn't the Fed have a limited ability to bring down long-term rates? Its most direct tools only affect short-term rates; its ability to affect long-term rates is less direct, relying on open-market purchase/sales and market perceptions of future inflation. Is the Fed's role at this point to 'lead from behind'? That is, if long-term rates continue to settle, it is a signal for the Fed to bring down short-term rates.
Also regarding fiscal dominance: is it correct to assume that the current upward trend is transitory? Since the yield curve is already inverted, and since short-term rates are low within their historic range, is it reasonable to conclude that the overall interest rate range is trending in a good direction?
I think there are some troubling signs and history. The Fed Fred graph HOANBS, hours worked for all workers, has pretty much predicted every recession back to 1948. It’s really an amazing graph to investigate. Currently it is mostly flat since Q1 2023. Only once has a recession not occurred after 2-3 quarters of flat or declining hours worked. It could be how the data is collected, because the total non farm employment mostly peaks right at the point a recession is declared (in hindsight) to start. But it could demonstrate employers cutting hours before they cut employees. I don’t know.
I’m actually skeptical the Fed controls very much of the entire interest rate curve. The data show the Fed nearly always behind the markets. Just look at the Tsy2 and Tsy10 yields vs the one thing the Fed controls, the Fed funds (and related discount window rate) in this cycle or any of all 6 periods always lags, often by 6 months or more, comparing the 2yr Tsy to FF. 10Tsy is noisier but shows similar characteristics. The Fed is always behind the markets, and this has applies also to downturns, where market yields fall earlier than the Fed.
The issue for a scientist is that if you showed these data to a competent scientist, not telling them what it was, they would note the facts, that the Fed in every tightening and then relaxing cycle, lags behind. So it’s not possible to construct a set of ordinary differential equations to describe the rate structure of the economy where the Fed Fends rate is an independent variable. In other words to a scientist the view of economists is trivially proven false. If rises in the FFR lag rises in other benchmark rates then it can’t be driving other rates. You can however model the system reasonably with the FFR as the dependent variable and some set of market rates as the independent variable.
If someone presented the graph of FFR, 2yr, 10yr Tsy, at a scientific meeting and said like economists do that the Fed had some control you would be laughed at in your presentation and forever considered an incompetent scientist.
We have two populists running for office. Mr. Biden needs to keep rates high to offset his deficit spending and resulting inflation which he conducts by sending generous transfer payments via his bureaucracy - the governors of states to his supporters. These payments ensure that his base vote for him and his party. On the other hand , Mr. Trump would like to directly affect the economy thru directly stimulating it with lower rates in the hope that growth and productivity outgain the deficits. Both are deficit spenders. Both will create inflation. Learn to live with it.
Apologies... this statement is irritating: " Very few people thought that the Fed would be able to quell the post-pandemic inflation without throwing large numbers of people out of work, but somehow they pulled it off."
Was it really the fed that did this ? or was it the massive infusion of technology (aided by the Covid shock) which impacted core productivity ? How much of what the Fed is doing in the financial sector is really kabuki theater while the real action is elsewhere ?
This is an interesting statement... I would love to see evidence it is actually true. From what I see, the general data collection methods driven by the Fed and Treasury lag the actually structural shifts in the economy.
What I mean is that the Fed (in principle) feeds all the data it has into its "model" (this may be no more that the collective seat of the pants of the FOMC :)) and sets it policy instruments to make its target come out on target or on its preferred trajectory for returning to target.
Yes...I understood. I am skeptical about the validity of the models in times of great structural changes. Also, the instruments which the Fed uses (ex interest rate policy) are increasingly decoupled from large parts of the economy (where access to capital is not an issue).
Overall, the "actions" which are driving economic growth, unemployment, and other key factors seem to be outside of the Fed. One could view this as good news.... I do.
Mostly it was because we stopped doing stupid stuff (QE, Covid stimulus. ZIRP) and so the inflation we caused wasn’t accommodated/extended with further reckless stimulus. Also, consumption patterns shifted away from goods (which had suffered from excess demand led price hikes) and back toward services.
The real Fed funds rate didn’t get into positive territory until April 2023, but MoM inflation data was falling by late 2022 so the Fed tightening didn’t cause it. The Fed has really only had restrictive policy since mid-2023: are we going to suffer from that as the monetary lag kicks in this year?
Or is current policy not really that restrictive at all given record budget deficits at full employment?
Lots of unanswered questions. Things don’t feel very much like 2019 (despite similar participation and unemployment rates and productivity and CPI) and certainly not the 1990s. I am not sure that we know how the “new normal” is going to play out.
1) The stupid stuff ... should have caused more inflation... why didn't it ? technology induced productivity is fundamentally deflationary
2) Feds restrictive policy should have raised unemployment ... especially if we believe the interest rate, lending cycle is the core to controlling deployed capital.. this did not happen either..why ? Investors have plenty of capital (just look at the top tech companies)... there is relative insensitivity to the debt cycle.
It caused a lot of inflation in a very short period of time- highest in 40+ years.
Tech innovation can be deflationary, for sure. However, productivity tools in managerial jobs have just expanded useless work and unnecessary communications to fill up time. The disinflation of the 90’s and 00’s was more a factor of globalization and offshoring and deregulation than technology.
Manufacturing will continue to benefit from automation, but is a tiny slice of the economy.
Services have proven to be immune from productivity gains, particularly the sectors controlled or distorted by government- healthcare, education and government itself.
But no way to quantify the individual contributing factors, like supply chain snarls. The EU wasn't nearly as generous spending on its citizenry, but suffered just as much inflation. The role of "price gouging" above and beyond increased production costs by multinationals like Unilever and Procter & Gamble also played a significant part.
I think patriots should be very concerned about Trump returning to power and should do everything they can to prevent that.
If you're Jerome Powell and of course you're a patriot, you should see that as a reason for cutting rates -- not just what it means for Fed independence, but because it's good for America and the world.
In terms of the Fed acting in a partisan way, which it would be doing here, this would have to be seen as a one-off. Not business as usual but drastic actions that must be taken because of the extreme nature of Trump.
He's either a great danger or he isn't. And he isn't. All should act accordingly.
The hikes did not cause the publicly advertised "mild" recession the Fed intended. Which would've definitely tanked Biden and the Dems in '24. As a suspicious Dem, I'd opined that Powell was partisan in jacking rates to get Trump re-elected: at considerable cost to the country. Now that we're past the recession iceberg (hopefully), considering the strain the hikes have already had on new housing starts, and economic start-ups in general, isn't it time for cuts?
That ten guys in thousand-dollar suits in a smoky back room can secretly decide American economic policy has never seemed right. Better to let the Fed be controlled by the House, who already control the power of the purse. Which is how other industrial democracies run their Central Banks, yes?
On a tangential note, I’m not sure how to take these.
“1. Fed Removes “The U.S. Banking System is sound and resilient” from the Policy Statement
On March 12, 2023, we all became aware of the regional banking crisis when the Fed and the FDIC stepped in to take over Silicon Valley Bank and Signature Bank. Markets were in a panic about the safety of banks.
…
New York Community Bank had taken over the failed Signature Bank in March 2023, with substantial assistance from the Fed and the FDIC. When they reported their earnings, they announced a 70% cut in their dividend, to $0.05 per share, as well as a massive $552 million increase in their loan loss provision. In addition, they reported a $252 million loss for the 4th quarter.”
“5. No Mention of the Fed’s -$114 billion Operating Loss for 2023
The final surprising development, to me, was that the Fed and Chairman Powell did not address the Fed’s recently released operating results, where they reported a loss of -$114 billion for 2023. Not only did Chairman Powell not bring it up, none of the financial reporters asked him a question about it.”
Thanks Noah for your very clear explanation as to why cutting rates when productivity is increasing should offset concerns about a wage/price increase. Very helpful for me to understand our current situation.
Yes but putting brakes on the economy in an election year with a Democratic incumbent helps elect responsible government, you know, tax and entitlement cutting Republicans.
On inflation, yes...though it was a combination of fed/govt policy and supply chain issues..... it is difficult to separate the two.
On tech innovation, yes.. agree globalization/offshoring was a big part.... however all of this was enabled by technology... wouldn't have happened without it. As you know, people measure income inequality at the national level, but at a global level income inequality fell...
On the impact of manufacturing/service, we disagree... I see massive changes in both ...with the exception of those distorted by the government...we certainly agree on that. However, even there, there is movement. Private online is the fastest growth segment in education (the Amazons of education are emerging). Healthcare is starting to absorb telemedicine techniques (agree..this is not material at this point).
I guess I'm in the "If it ain't broke, don't fix it" camp. I'm biased because I'm retired, love getting 5% money market rates, and do not have a mortgage. I certainly will not cry a river over real estate developers going bankrupt. They have made a fortune over the past several years, fueled by the low interest rates. If they are so leveraged they cannot function with the current rates, they probably deserve to go out of business. The biggest problem in our economy right now are home prices. Low mortgage rates will just cause another boom that will make home prices even higher, especially in popular locations. People focus too much on interest rates, and forget that the principal is what drives your mortgage payments.
I am not retired, but I agree- every time the Fed makes a move there are trade-offs, and lower interest rates are great for some, but not everyone. I too feel exactly as much concern for real estate developers that they would feel about any misfortunes it might cause me, and that’s not at all.
I couldn’t agree more, especially about housing. A healthy economy can sustain modest interest rates, that’s what we’re seeing now. A decade of ZIRP deeply messed up the economy, and we should be wary of going back to that.
I have a CD ladder going with my average rate at 5.1% every time one matures, I have been able to find higher rate for next one. Maybe that party will be over soon, but some of them go to 2028 at 5% or higher. Of course, all taxed at highest rate plus Obama care taxes, so the government collects more tax with higher rates to help offset the higher amount they pay to themselves on debt.
Workers shifted to more productive work during the pandemic. All-time record new-business formation occurred in 2020 and 2021. Fed policy aside, I give most of the credit to American citizens who met the pandemic challenge. Of course, Larry Summers said millions would need to lose jobs to reduce inflation. Summers also declared Bidenomics “the biggest economic policy in 50 years.”
I think when the history of this period is written, the coin-operated Congress missed a rare opportunity to take advantage of real interest rates at zero. Congress’ stupid, petty culture wars were more important because, as always, our elected leaders were laser-focused on raising PAC money for their re-election campaigns. American citizens are of secondary importance to the Congressional clown car.
The Fed will best be served when it ignore Trump. In fact, Trump fatigue will turn off more voters outside the Banana Republican base (maybe 30%, at best). Trump has ridden the Republican Party to three consecutive election-cycle losses, a strong trend the mainstream media likes to ignore because it doesn’t see advertising. The trend isn’t Trump’s and the mainstream media’s friend. Twenty million first-time Gen Z voters, let alone Gens X and Y will show Trump the door in November. Hundreds of anti-MAGA organizers are networking via Zoom. Trump gets beat by high single digits. He will start whining “this election is fixed” by mid-summer. His strategy is to bully and threatened with violence voters at the polling stations. It didn’t work last time. And it won’t work in 2024. Time to turn the page once again on the temporary aberration of Agent Orange.
God I hope you’re right
The question is, why has it not ALREADY cut interest rates? And I'm afraid that it because the Fed does not want to surprize the market, to do something it has not already said it would do or allowed an expectation to develop. This is "forward guidance" at its worst.
The simple statement of why they ought to cut is that inflation is falling, therefore real rates are rising. If, in fact, current policy has achieved a kind of Goldilocks-ian just-rightness, then _you need to cut to maintain that policy_. Declining to cut rates is, in effect, tightening policy, raising the risk of causing an unnecessary recession.
Well put. I don't know what r*, the policy rate that is consistent with stable (= target ?/=real income maximizing ?) inflation rate is and I don't think we need to know in order to believe that 5.25% is not it for the reasons you say.
They don’t want to start cutting and then have to hike because inflation bottoms and never sustainably reaches 2 pct. Both the labor market and consumer spending were much stronger than expected in Q4. Seems to have continued into January. Wage inflation is concerning. Productivity numbers have been volatile and unreliable since Covid- actually almost all economic data (and seasonal adjustments) have been volatile and unreliable since Covid.
I personally think the economy is going to slow over the next quarter and maybe grow 1-1.5 pct this year. Even if I am wrong and the economy stays strong, the Fed should be able to cut in May based upon policy becoming too restrictive in real rate terms.
That is probably a good explanation, but I disagree that they OUGHT to be reluctant to move and then back-track if necessary (although that seems quite unlikely). The message should, "We do this month what we think best to achieve our target and next month we will do what we think best to achieve our target."
It is nice that we have our 2019 economy back, and we only needed to spend 10 trillion more and suffer an inflationary bout to get it (and 7 pct of GDP deficits and growing ad infinitum)!
This economy is nothing like the 1990s, however. Monetary policy doesn’t exist in a vacuum but interacts with fiscal policy, which is as far removed from 1990s as ever (barring a couple years in WW2), and the 90’s also saw helpful disinflation and productivity impulses from globalization and rapid growth in EM (which led to excess/over investment and the Asian crisis, the Russian crisis, the Latam crisis, the telecoms bubble and the dot com bubble). Globalization isn’t a driver of disinflation currently (except in renewables due to Chinese overproduction).
100pct agree with you that we will get a rate cut in May or June, however. The economics/research team (many of whom originally hired by the very political/partisan Yellen and promoted under Powell) has laid sensible groundwork for it. Inflation has fallen to around 2.5pct, which puts real Fed Funds rates close to 3 pct- much tighter than they were in 2022 and most of 2023. The Fed probably wants to stay somewhat restrictive until inflation is reliably at/below 2 pct (will be helped by falls in CPI from the lagging housing components in 2024) but there is a good argument that 3 pct real rates are overkill, even with our unprecedented and irresponsible budget deficits at full employment. I don’t think we can ever do back to zero real Fed funds (which is what some of the Fed models still consider equilibrium) at full employment given our fiscal deficits, but 100 or 200bp over CPI/PCE seems possible. The Fed should cut rates to 4.625 by year-end, and maybe we could see a 3-handle in 2025 if the economy grows at 1-2pct this year and next and inflation bottoms out at 2-2.5.
Possible flies in the ointment are
1) it doesn’t seem as though Fed tightening actually has much impact on inflation. Real Fed funds was still negative in 2022 and early 2023 as inflation was falling rapidly. In other words, inflation fell because we stopped handing out trillions in stimulus and consumption patterns rebalanced between services and goods, allowing time for supply constraints to normalize, not because monetary policy was restrictive (it was less accommodative certainly, than the reckless 2021-2022 mix, but not restrictive at all in the historical sense….until the past 6-8 months). We will get some economic softening because of the high real rates of the last 6 months? This is the best argument for Fed cuts soon.
2) while the payrolls number/establishment survey showed 700k jobs created over the past 2 months, the household survey showed 700k jobs were LOST over the last 2 months. A 1.4mm discrepancy over 2 months is huge.
On the one hand I see the huge two month payrolls gain but no real change in participation or the unemployment rate and I think this should give the Fed comfort- this is a sign that maybe the population is increasing (the 6 million illegals waved through have to show up sometime) and we can support bigger payrolls increases.
But then I notice the household survey shows something completely different. So you can’t take the household data (unemp and part. rates) as comfort for the payrolls data. The payrolls data on its own shows overheating (payrolls growth above workforce growth, with 0.6 mom wage gains). The household data shows a slowing labor market and a declining population over the past two months (which has to be wrong). In other words, the data should be assumed to be gibberish for now and we’ll need a couple more months to see where things really are.
But are current interest rates actually "high"? Current US interest rates are just average for post-WW2. Even the so-called "low" interest rates of the 90s were about the same as they are now. It's the decade of near zero interest rates since the Great Recession that's the outlier.
But it's pretty logical that the setting of the instrument that reduced inflation to target needs to be adjusted to KEEP inflation at target.
If you just mean the EFFR probably should not go back to near zero, then I totally agree.
There is pretty strong evidence going back 700 years that interest rates decline. So averages of a few decades ago don't mean much. There is no stable long term average to reference.
The future is zero real interest rates. Sure, the GFC probably pushed us to 0 sooner than secular trends would have. So a slight rebound is understandable but current rates a higher than you'd expect given the 700 year trend of suprasecular declining rates.
For more see Schmelzing's research line this Bank of England paper. There were numerous popular write ups of it in 2020 when it was published you can Google as well.
https://www.bankofengland.co.uk/working-paper/2020/eight-centuries-of-global-real-interest-rates-r-g-and-the-suprasecular-decline-1311-2018
Good question. They seem high for the post GFC lost decade.
Are they high for a government (federal and state) running 7pc of GDP deficits at full employment? With globalization trends slowing?
Nobody knows. This is new territory.
Certainly doesn’t seem as if Fed policy since 2022 has been a driver of disinflation- that mostly happened on its own (H2 2022) while Fed policy was still accommodative by any historical standard.
Here is the link to a chart of real Fed funds over time
https://fred.stlouisfed.org/graph/?g=6TK
At some point your non-economist readers (cough cough) might benefit from a further discussion of Federal Reserve interest rate and liquidity levers, and its interaction with Treasury Department policy.
Even though inflationary expectations are low (as demonstrated by the inverted yield curve), doesn't the Fed have a limited ability to bring down long-term rates? Its most direct tools only affect short-term rates; its ability to affect long-term rates is less direct, relying on open-market purchase/sales and market perceptions of future inflation. Is the Fed's role at this point to 'lead from behind'? That is, if long-term rates continue to settle, it is a signal for the Fed to bring down short-term rates.
Also regarding fiscal dominance: is it correct to assume that the current upward trend is transitory? Since the yield curve is already inverted, and since short-term rates are low within their historic range, is it reasonable to conclude that the overall interest rate range is trending in a good direction?
I think there are some troubling signs and history. The Fed Fred graph HOANBS, hours worked for all workers, has pretty much predicted every recession back to 1948. It’s really an amazing graph to investigate. Currently it is mostly flat since Q1 2023. Only once has a recession not occurred after 2-3 quarters of flat or declining hours worked. It could be how the data is collected, because the total non farm employment mostly peaks right at the point a recession is declared (in hindsight) to start. But it could demonstrate employers cutting hours before they cut employees. I don’t know.
I’m actually skeptical the Fed controls very much of the entire interest rate curve. The data show the Fed nearly always behind the markets. Just look at the Tsy2 and Tsy10 yields vs the one thing the Fed controls, the Fed funds (and related discount window rate) in this cycle or any of all 6 periods always lags, often by 6 months or more, comparing the 2yr Tsy to FF. 10Tsy is noisier but shows similar characteristics. The Fed is always behind the markets, and this has applies also to downturns, where market yields fall earlier than the Fed.
The issue for a scientist is that if you showed these data to a competent scientist, not telling them what it was, they would note the facts, that the Fed in every tightening and then relaxing cycle, lags behind. So it’s not possible to construct a set of ordinary differential equations to describe the rate structure of the economy where the Fed Fends rate is an independent variable. In other words to a scientist the view of economists is trivially proven false. If rises in the FFR lag rises in other benchmark rates then it can’t be driving other rates. You can however model the system reasonably with the FFR as the dependent variable and some set of market rates as the independent variable.
If someone presented the graph of FFR, 2yr, 10yr Tsy, at a scientific meeting and said like economists do that the Fed had some control you would be laughed at in your presentation and forever considered an incompetent scientist.
We have two populists running for office. Mr. Biden needs to keep rates high to offset his deficit spending and resulting inflation which he conducts by sending generous transfer payments via his bureaucracy - the governors of states to his supporters. These payments ensure that his base vote for him and his party. On the other hand , Mr. Trump would like to directly affect the economy thru directly stimulating it with lower rates in the hope that growth and productivity outgain the deficits. Both are deficit spenders. Both will create inflation. Learn to live with it.
Apologies... this statement is irritating: " Very few people thought that the Fed would be able to quell the post-pandemic inflation without throwing large numbers of people out of work, but somehow they pulled it off."
Was it really the fed that did this ? or was it the massive infusion of technology (aided by the Covid shock) which impacted core productivity ? How much of what the Fed is doing in the financial sector is really kabuki theater while the real action is elsewhere ?
It was really the Fed, which acts taking account of all the things you mention.
This is an interesting statement... I would love to see evidence it is actually true. From what I see, the general data collection methods driven by the Fed and Treasury lag the actually structural shifts in the economy.
What I mean is that the Fed (in principle) feeds all the data it has into its "model" (this may be no more that the collective seat of the pants of the FOMC :)) and sets it policy instruments to make its target come out on target or on its preferred trajectory for returning to target.
Yes...I understood. I am skeptical about the validity of the models in times of great structural changes. Also, the instruments which the Fed uses (ex interest rate policy) are increasingly decoupled from large parts of the economy (where access to capital is not an issue).
Overall, the "actions" which are driving economic growth, unemployment, and other key factors seem to be outside of the Fed. One could view this as good news.... I do.
You are correct that Fed tools are not neutral across different kinds of economic activity. And should we even WANT them to be neutral?
Mostly it was because we stopped doing stupid stuff (QE, Covid stimulus. ZIRP) and so the inflation we caused wasn’t accommodated/extended with further reckless stimulus. Also, consumption patterns shifted away from goods (which had suffered from excess demand led price hikes) and back toward services.
The real Fed funds rate didn’t get into positive territory until April 2023, but MoM inflation data was falling by late 2022 so the Fed tightening didn’t cause it. The Fed has really only had restrictive policy since mid-2023: are we going to suffer from that as the monetary lag kicks in this year?
Or is current policy not really that restrictive at all given record budget deficits at full employment?
Lots of unanswered questions. Things don’t feel very much like 2019 (despite similar participation and unemployment rates and productivity and CPI) and certainly not the 1990s. I am not sure that we know how the “new normal” is going to play out.
Well... here is my take...
1) The stupid stuff ... should have caused more inflation... why didn't it ? technology induced productivity is fundamentally deflationary
2) Feds restrictive policy should have raised unemployment ... especially if we believe the interest rate, lending cycle is the core to controlling deployed capital.. this did not happen either..why ? Investors have plenty of capital (just look at the top tech companies)... there is relative insensitivity to the debt cycle.
It caused a lot of inflation in a very short period of time- highest in 40+ years.
Tech innovation can be deflationary, for sure. However, productivity tools in managerial jobs have just expanded useless work and unnecessary communications to fill up time. The disinflation of the 90’s and 00’s was more a factor of globalization and offshoring and deregulation than technology.
Manufacturing will continue to benefit from automation, but is a tiny slice of the economy.
Services have proven to be immune from productivity gains, particularly the sectors controlled or distorted by government- healthcare, education and government itself.
But no way to quantify the individual contributing factors, like supply chain snarls. The EU wasn't nearly as generous spending on its citizenry, but suffered just as much inflation. The role of "price gouging" above and beyond increased production costs by multinationals like Unilever and Procter & Gamble also played a significant part.
I think patriots should be very concerned about Trump returning to power and should do everything they can to prevent that.
If you're Jerome Powell and of course you're a patriot, you should see that as a reason for cutting rates -- not just what it means for Fed independence, but because it's good for America and the world.
In terms of the Fed acting in a partisan way, which it would be doing here, this would have to be seen as a one-off. Not business as usual but drastic actions that must be taken because of the extreme nature of Trump.
He's either a great danger or he isn't. And he isn't. All should act accordingly.
Why do you think productivity is growing so strongly? Remote work? AI? A bunch of unrelated inventions all coming ripe at the same time?
The hikes did not cause the publicly advertised "mild" recession the Fed intended. Which would've definitely tanked Biden and the Dems in '24. As a suspicious Dem, I'd opined that Powell was partisan in jacking rates to get Trump re-elected: at considerable cost to the country. Now that we're past the recession iceberg (hopefully), considering the strain the hikes have already had on new housing starts, and economic start-ups in general, isn't it time for cuts?
That ten guys in thousand-dollar suits in a smoky back room can secretly decide American economic policy has never seemed right. Better to let the Fed be controlled by the House, who already control the power of the purse. Which is how other industrial democracies run their Central Banks, yes?
On a tangential note, I’m not sure how to take these.
“1. Fed Removes “The U.S. Banking System is sound and resilient” from the Policy Statement
On March 12, 2023, we all became aware of the regional banking crisis when the Fed and the FDIC stepped in to take over Silicon Valley Bank and Signature Bank. Markets were in a panic about the safety of banks.
…
New York Community Bank had taken over the failed Signature Bank in March 2023, with substantial assistance from the Fed and the FDIC. When they reported their earnings, they announced a 70% cut in their dividend, to $0.05 per share, as well as a massive $552 million increase in their loan loss provision. In addition, they reported a $252 million loss for the 4th quarter.”
“5. No Mention of the Fed’s -$114 billion Operating Loss for 2023
The final surprising development, to me, was that the Fed and Chairman Powell did not address the Fed’s recently released operating results, where they reported a loss of -$114 billion for 2023. Not only did Chairman Powell not bring it up, none of the financial reporters asked him a question about it.”
https://seekingalpha.com/article/4667016-fed-removes-us-banking-system-sound-and-resilient-from-policy-statement-other-revelations?mailingid=34227664&messageid=must_reads&serial=34227664.3450000&utm_campaign=Must%2BReads%2Brecurring%2B2024-02-03&utm_content=seeking_alpha&utm_medium=email&utm_source=seeking_alpha&utm_term=must_reads
Thanks Noah for your very clear explanation as to why cutting rates when productivity is increasing should offset concerns about a wage/price increase. Very helpful for me to understand our current situation.
Yes but putting brakes on the economy in an election year with a Democratic incumbent helps elect responsible government, you know, tax and entitlement cutting Republicans.
Sarcasm?
On inflation, yes...though it was a combination of fed/govt policy and supply chain issues..... it is difficult to separate the two.
On tech innovation, yes.. agree globalization/offshoring was a big part.... however all of this was enabled by technology... wouldn't have happened without it. As you know, people measure income inequality at the national level, but at a global level income inequality fell...
On the impact of manufacturing/service, we disagree... I see massive changes in both ...with the exception of those distorted by the government...we certainly agree on that. However, even there, there is movement. Private online is the fastest growth segment in education (the Amazons of education are emerging). Healthcare is starting to absorb telemedicine techniques (agree..this is not material at this point).