The Fed’s next rate hike: what’s the rationale?

May 23rd, 2016 at 9:03 am

That’s what I struggle with over at today’s WaPo, along with connections to impressionist art and goat droppings. Like a number of analyses I’ve been posting of late, I find little passthrough from wage to price growth, even accounting for slower productivity growth.

The Post piece references a number of sensitivity checks of the finding that wage growth is not obviously nudging up price growth without showing the figures. Here, for OTEers only, are some extra figs.

Using wage growth instead of compensation growth doesn’t make any difference:

Source: see data note in Post piece.

Source: see data note in Post piece.

What about using quarterly annualized changes instead of year-over-year changes? As these data are considerably noisier, that too ends up showing bupkiss.

Source: see data note in Post piece.

Source: see data note in Post piece.

Some colleagues noted that it’s a little odd to pick on Lacker because he always wants to raise. Fair point, but I thought the most recent Fed minutes also had moments of MONETary policy versus the more data driven approach:

“Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen and inflation making progress toward [their 2 percent inflation] objective,” then an increase in June would likely “be appropriate.”

Yes, as I show in various places, wages and prices are “firming” a bit. That’s both good and totally expected as the job market improves and the price of oil slowly climbs back to more normal levels. The question is all about linkages to inflation, which is what I try to get at in my admittedly simple approach.

Let me leave you with this. It’s critical to elevate the role of international dynamics, including capital flows, in one’s thinking about these price dynamics. In this regard, I consider this ‘graf by Fed governor Brainard to be one of the more important these days:

Recent events suggest the transmission of foreign shocks can take place extremely quickly such that financial markets anticipate and indeed may thereby front-run the expected monetary policy reactions to these developments. It also appears that the exchange rate channel may have played a particularly important role recently in transmitting economic and financial developments across national borders. Indeed, recent research suggests that financial transmission is likely to be amplified in economies with near-zero interest rates, such that anticipated monetary policy adjustments in one economy may contribute more to a shifting of demand across borders than a boost to overall demand. This finding could explain why the sensitivity of exchange rate movements to economic news and to changes in foreign monetary policy appear to have been relatively elevated recently.

I will dive into this in a forthcoming post, as I believe these insights also militate against rate hikes without clear rationales re inflationary pressures, as higher rates exacerbate the flows problem for the US. But in the meantime, here are your reading assignments: the talk from which that ‘graf is pulled and one of the papers underlying this important argument.

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2 comments in reply to "The Fed’s next rate hike: what’s the rationale?"

  1. Bob says:

    To further complicate matters, wage growth and productivity increases are on opposite ends of a teeter totter.

    A shorthand definition of productivity is, value created per labor hour worked. If you want a worker to be more productive, give him a more efficient machine to run.

    But there is a downside to that. Management is under no obligation to share extra wealth created with workers in the form of wage growth. Instead, management can use productivity increases to reduce workforce. I know: I made those decisions. Result: fewer workers are producing more wealth, so jobs remain hard to get.

    When things got tough in the economy, humans were the first things to downsize. You could lay a worker off the next morning, but you couldn’t fire that multimillion dollar investment in new machinery you made the year before.