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February 2, 2015

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Fed Watch: As of Yet, Fed Not Changing Tune

Posted: 02 Feb 2015 12:15 AM PST

Tim Duy:

As of Yet, Fed Not Changing Tune, by Tim Duy: Early salvos by Federal Reserve policymakers in the wake of last week's FOMC non-event suggest that recent developments have had little impact on Fed thinking with regards to the appropriate timing of rate hikes. The middle of this year remains the internal forecast. Whether data or events cooperate is of course another question.

I think it is worth viewing Friday's two interviews with St. Louis Federal Reserve President James Bullard at Bloomberg and San Francisco Federal Reserve President John Williams at CNBC. Bullard is fairly clear in his view that financial markets are doing it wrong:

"The market has a more dovish view of what the Fed is going to do than the Fed itself," Bullard said in an interview Friday in New York. "Markets should take it at face value" from the Fed's rate projections, and it's "reasonable" to expect an increase in June or July.

In contrast, I would say that Williams is a bit more cautious:

Given this projection, Williams said he thought "around the middle of this year is the time that I think, in my view, that we'll be getting closer to 'Should we raise rates now, or should we wait a little longer, collect some more data, get more confidence in the forecast?'"

The baseline story, however, is generally the same. They believe the US economy has sufficient momentum to weather any external shocks. They both view the first quarter GDP report as consistent with their underlying forecast. So did I, for that matter. You need to be able to tease out the underlying trend when parsing the data. Calculated Risk gets it right. R-E-L-A-X:

There are legitimate concerns about a strong dollar, and weak economic activity overseas, impacting U.S. exports and GDP growth. However, overall, the Q4 GDP report was solid.

In short, neither Williams nor Bullard is seeing anything in the recent data to worry them significantly. Regarding the timing of a rate hike, I think that if you view the videos, you will see a line of logic fairly similar to what I described last week. They see unemployment falling to 5% or less this year. They do not think that such a situation as consistent with zero rates. They think they need to move ahead of actual inflation. They think that even after hiking rates, monetary policy will remain accommodative.

A couple of clarifications and extensions:

First, my take is that the Fed wants to pull the focus off of the first rate increase to the subsequent path of policy. What comes first is not as important as what comes after. The "comes after" is one reason they want to move sooner than later given the current economic environment. Bullard views it important to narrow the gap between zero and normal rates because he fears that falling behind the curve will necessitate a steeper subsequent policy path. This thinking is probably endemic within the Federal Reserve.

Second, notice that again Bullard dismisses market-based measures of inflation expectations as distorted by the massive drop in the price of oil. And his opinion is not illogical: There is no reason to think 5y5y forward exceptions to be impacted in lock step with the collapse in oil prices. He wants to see how that situation plays itself out.

Third, Bullard says that we are 400bp below normal policy and that his view of normal policy has not changed much. There is no new normal. This too I think is endemic in Fed thinking and where I think lies the greatest potential for a policy error. They should not be holding a dogmatic view of what is normal. The bond markets are telling me that would be a mistake.

Fourth, Bullard was not disturbed by the rise of the dollar as he sees it as a natural consequence of a stronger US economy and weaker economies abroad. This contrasts with the general view that the Fed is panicking over the dollar.

So what does Fed Chair Janet Yellen think? Well, both Bullard and Williams are coming right out of the gates of an FOMC meeting, and I doubt either would take a position that was strongly in contrast to Yellen. That said, expectations seem to be growing for Yellen to head a different direction. Via the Wall Street Journal:

"If the markets stay how they are today three months from now, the Fed would have a hard time raising interest rates," Alan Rechtschaffen, a financial adviser at UBS, said this week. That would make Ms. Yellen's twice-yearly testimony before the House and Senate, expected in the third week of next month, a potential opportunity for beginning to show increased concern about low inflation—particularly if measures of prices excluding energy and food costs keep moving lower.

"As early as the Humphrey-Hawkins testimony the Fed could begin to lay the groundwork for a transition in monetary policy" toward a later date for interest-rate increases, Mr. Rechtschaffen said.

Like I thought that there would be little change in the FOMC statement, I am cautious about expecting a change in Yellen's tone. It might be good to consider this anecdote from former Federal Reserve Governor Larry Meyer:

The final question is whether Janet is really a dove. Let me tell you a story. Janet and I held very similar views when we were colleagues on the Committee, despite the fact that I was immediately viewed as a hawk and she was already viewed as a dove. (I thought of myself at the time as being a "hawkish dove.") In any case, when it comes to ensuring price stability and maintaining well-anchored inflation expectations, there are no doves on the Committee. Before the September 1996 FOMC meeting, Janet and I went to see the Chairman to talk about the policy decision at that meeting and at following meetings. This was the only time I ever visited the Chairman (at my initiative) to talk about monetary policy, before or after a meeting. Janet and I were both worried about inflation, even though it was very well contained at the time. We told the Chairman that we loved him but could not remain at his side much longer if he continued, as he had been doing for some time, to push the next tightening action into the next meeting, and then not follow through. He listened, more or less patiently. I recall, though this may have not been the case, that he just smiled and didn't say a word. After an awkward silence, we said our good-byes. Needless to say, we didn't win this argument. Yet, we never dissented. That is another matter of etiquette for the entire Board, at least since when I was there: The Board is a team, always votes as a block, and, therefore, always supports the Chairman.

The reason I bring this up is that if my analysis of the Fed's baseline thinking is generally correct, then Yellen will have a hard time staying a dove if her underlying framework is unchanged from 1996. And I think we are seeing that as the economy heads into more normal territory, that underlying framework is indeed unchanged. This is especially the case when she could view former Federal Reserve's Chair Alan Greenspan's 1996 bet as being a special case attributable to higher productivity, and she does not have productivity in her corner this time around. Just something to think about.

Bottom Line: I am not convinced the Fed is changing its thinking as quickly as markets think the Fed is changing its thinking. That means that Fedspeak might continue to be hawkish relative to expectations.

Links for 02-02-15

Posted: 02 Feb 2015 12:06 AM PST

'Saying the Obvious' (about Fiscal Policy)

Posted: 01 Feb 2015 08:43 AM PST

Simon Wren-Lewis:

Saying the obvious: Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity. And they would be right, as I set out in this recent VoxEU piece. There I present some back of the envelope calculations, but they are confirmed by model simulations: not just those I quoted in the text, but also others that I did not have space to mention.
When writing that piece, I kept having doubts. Not about the analysis, but just that this was all so obvious. It uses basic models (DSGE or more eclectic) that we teach undergraduates and postgraduates. It is supported by the clear majority of empirical evidence. I felt like I was telling people the macroeconomic equivalent of a rise in the demand for apples will mean an increase in their price.

The reason I put those doubts aside are also familiar. The fact that at least half the world's politicians and mediamacro continue to ignore the obvious. ...

Economics is always in danger of being corrupted by politics and ideology, and macroeconomics seems particularly vulnerable in this respect. ... Some say that this corruption is inevitable and that we should embrace it, rather than attempt to avoid it through delegation to institutions like independent central banks. I disagree: demand management is basically a technical issue with political implications. If we did not have independent central banks today, I suspect we would be seeing the US congress voting to raise interest rates. And of course there would be a few economists with their models saying it was a good idea, even though the vast majority thought otherwise. ...

We therefore need to rethink how stabilisation policy is done at the Zero Lower Bound (ZLB)..., so it would be prudent to complete the delegation of macroeconomic stabilisation policy that was begun by making the operation of interest rate policy independent of political control. Doing that would also be a good opportunity to revisit the arrangements that can ensure independence is compatible with accountability and some degree of democratic oversight.   

'Demographics and GDP: 2% is the New 4%'

Posted: 01 Feb 2015 08:27 AM PST

Calculated Risk:

Demographics and GDP: 2% is the new 4%: For amusement, I checked out the WSJ opinion page comments on the Q4 GDP report. As usual, the WSJ opinion is pure politics - but it does bring up an excellent point (that the WSJ conveniently ignores).

First, from the WSJ opinion page:

The fourth quarter report means that growth for all of 2014 clocked in at 2.4%, which is the best since 2.5% in 2010. It also means another year, an astonishing ninth in a row, in which the economy did not grow by 3%.

This period of low growth isn't "astonishing". First, usually following a recession, there is a brief period of above average growth - but not this time due to the financial crisis and need for households to deleverage. So we didn't see a strong bounce back (sluggish growth was predict on the blog for the first years of the recovery).

And overall, we should have been expecting slower growth this decade due to demographics - even without the housing bubble-bust and financial crisis (that the WSJ opinion page missed). ...

The good news is that will change going forward (prime working age population will grow faster next decade). The bad news is the political hacks will continue to ignore demographics.

Right now, due to demographics, 2% GDP growth is the new 4%.

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