Fed in an interesting zone: strong growth, weak inflation

January 28th, 2015 at 5:54 pm

You’re hanging out at a party with your spouse. He’s a charming guy, life of the party, but he’s been known to get embarrassingly drunk and start breaking things. You watch him closely, observing that he’s drinking heavily as usual and you’re getting ready to shove in the car before things get ugly. But weirdly, they don’t. He’s knocking back the booze but increasingly coherent, funny, and engaging. What should you do?

OK, perhaps not the best analogy but that’s the dilemma facing the Fed, whose FOMC released their statement this afternoon, pledging patience on the rate liftoff, even as growth accelerates. Why the patience? Because price growth is low–consistently below their 2% target–and is “anticipated to decline further in the near term” before gradually rising back up to 2%.

My favorite way to look at the statement is through the WSJ’s Fed Statement Tracker, which shows the words they changed from the last statement (given that some of my papers did double duty back in the old college days, I glad my profs didn’t have one of these). The tracker shows tweaks of “moderate” to “solid” and “solid” to “strong” as well as an added hat tip, though a slight one, to international weakness.

Will any of this fundamentally change the liftoff forecast from the middle of this year to later on? According to the NYT, ‘”Morgan Stanley [analysts] predicted Monday that the Fed will not raise rates until 2016: “We believe the FOMC would risk entrenching inflation expectations at levels inconsistent with its 2 percent goal if it were to push forward with rate hikes as early as June.”’

That’s an interesting and plausible take. As I’ve written elsewhere, based on recent price and wage dynamics, they may also need to mark down their NAIRU (their 5.4% estimate of the lowest unemployment rate consistent with stable inflation).

The big story in Fed watching if you ask me is what if the party gets going and everyone remains well-behaved? Then you don’t need to be so quick to take away the punch bowl. Right?

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2 comments in reply to "Fed in an interesting zone: strong growth, weak inflation"

  1. Tom in MN says:

    Right. Especially if the punch bowl only has 2% of the good stuff in it when what it needs to get the party really going is at least 4%. (Inflation target that is…)


  2. Smith says:

    First, I’d like to know more about how they figure the 5.4%. That pretty much dooms hope of long term wage gains. Inflation rises too soon in the face of rising employment because business won’t give up any share of profits, they raise prices instead. If you can’t break the business stranglehold on the economy by their ability to control (raise) prices at will (fettered competition), you’ll never restore labor power, see full employment, rising wages, or lower inequality. 5.4% = stagnant wage forever, rising inequality ad infinitum.

    In August, Brad DeLong had an interesting graph and analysis of where the recovery stood:

    http://delong.typepad.com/sdj/2014/08/over-at-equitable-growth-in-which-i-make-myself-very-confused-about-cyclical-recovery-monday-focus-for-august-18-2014.html

    If you update the graph, you’ll see the analysis still holds as numbers haven’t moved significantly enough from 2Q 2014 to 4Q 2014 to change the only 1/3 back evaluation.

    http://research.stlouisfed.org/fred2/graph/?chart_type=line&recession_bars=on&log_scales=&bgcolor=%23e1e9f0&graph_bgcolor=%23ffffff&fo=verdana&ts=12&tts=12&txtcolor=%23444444&show_legend=yes&show_axis_titles=yes&drp=0&cosd=1990-01-01%2C1990-01-01&coed=2014-12-01%2C2014-12-01&width=670&height=445&stacking=&range=Custom&mode=fred&id=LNS11300060%2CLREM25TTUSQ156S&transformation=lin&nd=&ost=-99999&oet=99999&scale=left&line_color=%234572a7&line_style=solid&lw=2&mark_type=none&mw=1&mma=0&fml=a&fgst=lin&fgsnd=2007-12-01&fq=Monthly&fam=avg&vintage_date=&revision_date=


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