It’s (likely) Fed liftoff week, so what better way to start…

December 14th, 2015 at 9:13 am

…the week than with a bit of Fed’ish macro.

I’m resigned to the 25 bp increase (0.25%) the Fed is expected to announce later this week. After all the telegraphing/forward guidance to that effect, it would be disconcerting for them not to do so, suggesting there’s something wrong they’ve been hiding from the rest of us.

But there’s a lot more downside than upside risk, as I stress here and Andy Levin stresses here (that’s a lot of stress!).

Then there’s this interesting WSJ piece out this AM on the difficulty economists, including those at the Fed, are having in understanding inflation. The piece suggests these reasons for the disconnect:

demographics: Aging demographics tilts population shares towards those who spend more meagerly out of savings and this weakens demand. If you go to Alvin Hansen’s original thinking on secular stagnation, he stresses demographics as well, specifically slower population growth. BTW, this suggests that demographic variables such as the share of the population over 65 should load negatively in Phillips Curve models. The exercise is left to the reader (let me know what you find; my guess is it’d be hard to tease out this signal).

temporary factors: This is the Fed’s main explanation. Chair Yellen has suggested that the oil glut and the strong dollar are tamping down the usual correlation between slack and prices, and once they fade, the “Phillips Curve” will spring back into action.

globalization: Much more extensive supply chains mean a lot more global price competition and this holds down prices in ways historical models fail to reflect. This implies the Fed has less power than they think to move inflation around.

there’s still slack: It’s not just that temporary factors are masking inflation. It’s that output gaps remain large enough to dampen inflationary pressure. That’s implicit in my WaPo piece today and would militate against a preemptive rate hike.

who knows?: Economists don’t really understand what drives inflation these days. A key point here is that we’ve learned that wage growth doesn’t map onto price growth the way the classic model predicts. That’s a big change, one Yellen herself has endorsed. And a reason for the Fed to allow some wage growth to persist before giving the brakes another tap.

My take is that globalized supply chains are more important than inflation modellers typically realize. I’ve not thought enough about the demographic point, but there may be something there as well. And, of course, I’m a big advocate of the view that there’s still slack in the job market (the underemployment rate is 1.4 points above what I believe to be its full employment rate of 8.5%).

Finally, I get that everyone wants to make snazzy graphics that don’t just have the same old lines on the graph. But I stared at this graphic in the WSJ piece for about half-a-cup of my AM coffee, thinking surely as the caffeine did its work, I’d see what they were getting at. But to no avail. Perhaps that’s because I’m pretty color blind–I think they’re trying to show the sort of thing you see in the second figure here, plotting actual inflation against the Fed’s optimistic forecasts–but more likely, this is just a not-very-intelligible way to plot the data.

Source: Wall St. Journal

Source: Wall St. Journal

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3 comments in reply to "It’s (likely) Fed liftoff week, so what better way to start…"

  1. Flex says:

    Not that I’m trained in economics, but could inequality also negatively load the Phillips curve?

    My thinking is as follows:

    If demographics can be a factor because an aging population watches their spending more, then an increase in the population which has always had to watch their spending closely might also reduce demand and thus inflation.

    Quite a few economic indicators start to change in the late 1970’s, early 1980’s, and quite a few of them have been linked to increases in inequality which began around that time.

    If you could calculate estimated Phillips curves for the U.S.A. as far back as 1900, it might be interesting to see if the post-WWII economic boom was also reflected in the inflation rates.

    We generally think of inflation as a result of scarcity or an over-abundance of currency, but the second condition could be caused by increased discretionary income.

  2. Tom in MN says:

    Also the 2% inflation target is just a guess, or even wishful thinking. They don’t know that this number is the proper target that puts the economy into steady state. Currently with decades of dropping long term rates, that would be hard to claim.

  3. readerOfTeaLeaves says:

    My key takeaway from the lovely colored graph: the disconnect between reality and forecasts is accelerating. The people at the Fed may as well be trying to read oracle bones.

    Meanwhile, supposing the Fed is a creature of private banks, it is not really surprising that the Fed is farther and farther away from what’s actually happening — the Fed seems not to be tracking the explosive growth of private debt – particularly real estate [see also: liar’s loans, 2008 implosion, foreclosures, etc, etc].

    I think that Lord Adair Turner is starting to target a problem that lies beneath global supply chains, beneath globalization, beneath demographics. As Turner points out — and I’ve sure seen it in the northern end of Puget Sound! — private banks been funding real estate, **not** business growth.

    Where I am, (smart) venture capitalists have been much better funders of new business growth than traditional banks have been. And Wells Fargo or Citibank or BoA?! Fuhgettaboutit!! They don’t have the smarts or chutzpah to fund new businesses, and frankly that may be a good thing: God only knows how many Pet Rock frauds they’d fund.

    But the notion that banks actually drive small business growth strikes me as a notion that is by now well beyond its pull date — and yet, the Congress, the Fed, and business media seem to cater to banks as if they are the keys to economic growth. At this point, they are killing the economy with inflated real estate loans.

    IMVHO, these banks are continuing to accelerate real estate speculation. Look at the ratio of real estate debt to actual capital being directed to new or novel business ideas, and you’re almost certainly going to see that the banks have become the economic equivalent of Jabba the Hutt.