Redirect


This site has moved to http://economistsview.typepad.com/
The posts below are backup copies from the new site.

July 9, 2014

Latest Posts from Economist's View

Latest Posts from Economist's View


Fed Watch: When The Fed Starts Raising Rates

Posted: 09 Jul 2014 12:24 AM PDT

Tim Duy:

When The Fed Starts Raising Rates, by Tim Duy: Via Twitter, modest proposal summarizes my last post:
Shorter @TimDuy, short the front end not the 10 year because the Fed will tighten before inflation is a problem http://t.co/1a0xRNueEO
— modest proposal (@modestproposal1) July 7, 2014
This made me think about the last tightening cycle. For those that hope to use tighter monetary policy to bolster the case against equities, recall that patience may be required:

FedTight1

For those making the bear case against long bonds, recall that initially long rates fell, and over the entire cycle rose just (roughly) 50bp:

FedTight2

The short end of the curve suffered, and the yield curve inverted:

FedTight3

How does this compare to now? If we consider last December's taper the beginning of this tightening cycle (the Fed does not; they prefer to think of it at reducing financial accommodation), stocks continue to power higher:

FedTight4

The 10 year bond initially fell on the taper talk and the yield curve steepened through the 10 year. But that steepening ended when the taper began:

FedTight5

More interesting is the flattening of the very long end after the taper began:

FedTight6

It looks like rates are signalling that the Fed will act to contain activity such that the economy does not overheat. Which, assuming the Fed maintains its current reaction function, tends to support modest porposal's interpretation - favor the long end of the curve over the short end.
I think the flattening of the yield curve should be a concern to the Fed. It suggests that while we frequently hear Janet Yellen described as a dove, the expectation is that her actual policy approach will be cautious bordering on hawkish. Not good if you think like Andy Harless:
I will consider Yellen's tenure a failure if the economy does not overheat.
— Andy Harless (@AndyHarless) July 5, 2014
I am sympathetic to this view. I would be a little more optimistic that the Fed would have more room to maneuver in the next recession if the long-end of the yield curve was signalling that the Fed was a little behind instead of a little ahead. And for more on why that is important, see Brad DeLong and his 17 tweet bear case for inflation.

Links for 7-09-14

Posted: 09 Jul 2014 12:06 AM PDT

'The Unemployment Cost of Below-Target Inflation'

Posted: 08 Jul 2014 01:46 PM PDT

Carola Binder:

The Unemployment Cost of Below-Target Inflation: Recently, inflation in the United States has been consistently below its 2% target. The situation in Sweden is similar, but has lasted much longer. The Swedish Riksbank announced a 2% CPI inflation target in 1993, to apply beginning in 1995. By 1997, the target was credible in the sense that inflation expectations were consistently in line with the target. From 1997 to 2011, however, CPI inflation only averaged 1.4%. In a forthcoming paper in the AEJ: Macroeconomics, Lars Svensson uses the Swedish case to estimate the possible unemployment cost of inflation below a credible target...

The unemployment rate would be about 0.8% lower if inflation averaged 2% (and presumable lower still if inflation averaged slightly above 2%). ...

Svensson concludes with policy implications:

"I believe the main policy conclusion to be that if one wants to avoid the average unemployment cost, it is important to keep average inflation over a longer period in line with the target, a kind of average inflation targeting (Nessén and Vestin 2005). This could also be seen as an additional argument in favor of price-level targeting...On the other hand, in Australia, Canada, and the U.K., and more recently in the euro area and the U.S., the central banks have managed to keep average inflation on or close to the target (the implicit target when it is not explicit) without an explicit price-level targeting framework.  
Should the central bank try to exploit the downward-sloping long-run Phillips curve and secretly, by being more expansionary, try to keep average inflation somewhat above the target, so as to induce lower average unemployment than for average inflation on target?...This would be inconsistent with an open and transparent monetary policy."

[See the full post for more details.]

No comments: