One of the major economic stories of last year was the rise in US interest-rates. The US Federal Reserve is keen to tell us it was rapid but the main issue was sung about by Carole King.
And it’s too late, baby, now it’s too lateThough we really did try to make itSomethin’ inside has died
Monetary policy is supposed to get ahead of events due to the lags in the system a subject I will return to. But instead we got a central bank chasing inflation’s rise rather than getting ahead of it. A consequence of the move was that we saw a strong US Dollar last year, which via its role as the reserve currency in which commodities are priced. made inflation worse for everyone else.
Let us remind ourselves of where things stand.
In support of these goals, members agreed to raise the target range for the federal funds rate to 4¼ to 4½ percent.
Last night’s Fed ( FOMC) Minutes contained some rather aggressive rhetoric.
In discussing the policy outlook, participants continued
to anticipate that ongoing increases in the target range
for the federal funds rate would be appropriate to
achieve the Committee’s objectives.
Not so much that bit but more this.
A number of participants emphasized that it would be important to clearly communicate that a slowing in the pace of rate increases was not an indication of any weakening of the Committee’s resolve to achieve its price-stability goal or a judgment that inflation was already on a persistent downward path,
Then here.
Participants generally indicated that upside risks to the
inflation outlook remained a key factor shaping the outlook for policy
As to rate cuts well we got an official denial.
No participants anticipated that it would be appropriate to
begin reducing the federal funds rate target in 2023.
Apart from the track record of official denials there is also the track record of the Federal Reserve in forecasting the future!
As ever the rhetoric is contradictory as one the one hand.
In view of the persistent and unacceptably high level of inflation, several participants commented that historical experience cautioned against
prematurely loosening monetary policy.
But on the other rather than being rigid it needs to be flexible.
Participants generally noted that the Committee’s future decisions regarding policy would continue to
be informed by the incoming data
The message overall is that they intend to keep raising interest-rates.
Neel Kashkari
The President of the Minneapolis Fed wrote a piece on Medium yesterday. There were several things we could take from it. Firstly he got things very wrong.
To state clearly, I was solidly on “Team Transitory,” so I am not throwing stones.
Then confesses implicitly that the Group think I accused central bankers of was true.
But many of us — those inside the Federal Reserve and the vast majority of outside forecasters — together made the same errors in, first, being surprised when inflation surged as much as it did and, second, assuming that inflation would fall quickly. Why did we miss it?
Oh and he also confesses to another criticism of mine which is preferring economic models over real world experience.
The inflation in this example is not driven by the two primary sources that traditional Phillips-curve models used by policymakers, researchers, and investors consider: (1) labor market effects via unemployment gaps, and (2) changes to long-run inflation expectations.
Actually the Phillips-curve stuff is especially poor as it was quite clear that the credit crunch changes things fundamentally for it.
If we return to the timing point I make so often Neel seems to have no idea about it at all.
While I believe it is too soon to definitively declare that inflation has peaked, we are seeing increasing evidence that it may have. In my view, however, it will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked.
This is a really big deal because in monetary policy if you wait to be “sure”, the one thing you are likely to be is wrong. This is because you have lags in the data arriving as well as lags before policy actions begin to work. But as you can see Neel is trying to present himself as a doughty inflation fighter.
Once we reach that point, then the second step of our inflation fighting process, as I see it, will be pausing to let the tightening we have already done work its way through the economy. I have us pausing at 5.4 percent, but wherever that end point is, we won’t immediately know if it is high enough to bring inflation back down to 2 percent in a reasonable period of time.
One might have reasonably thought that after confessing to the problems with economic models he should have the sense to steer clear of a precise number like that. Especially as the US does not move in sizes that get you to 5.4%. Also we got another official denial about interest-rate cuts.
Given the experience of the 1970s, the mistake the FOMC must avoid is to cut rates prematurely and then have inflation flare back up again.
International Monetary Fund
This too has weighed in on the subject via an interview with the Financial Times.
Inflation in the US has not “turned the corner yet” and it is too early for the Federal Reserve to declare victory in its fight against soaring prices, a top IMF official has warned.
You might think that with the track record of the IMF in recent years it would avoid giving advice to others. But, instead it has a policy prescription as well.
In an interview with the Financial Times Gita Gopinath, the fund’s second-in-command, urged the US central bank to press ahead with rate rises this year despite a recent moderation in headline inflation following one of the most aggressive tightening campaigns in the Fed’s history.
As you can see the Financial Times is high on the hype here with “top official” and “second-in-command”. They seem unable to stop it.
The comments from the fund’s deputy managing director
But whilst not quite as aggressive as Neel Kashkari we get to the point.
Gopinath backed the Fed’s benchmark rate rising to about 5 per cent and staying there throughout this year, in an effective endorsement of the latest “dot plot” projections from US central bank officials.
Comment
It is hard not to have a wry smile at a reality where central bankers claim to have abandoned Forward Guidance and then give us specific numbers for future interest-rates. In many ways 5.4% is as specific as they have ever got. That gets us to the crux of the issue because they actually believe that the ordinary person takes notice of them. I used to think of that as a pure fantasy but after all the errors it is more than that.
Every man has a place, in his heart there’s a spaceAnd the world can’t erase his fantasiesTake a ride in the sky, on our ship, FantasyAll your dreams will come true, right away ( Earth, Wind & Fire)
The only people who believe this are the central bankers and their media acolytes. In their journey towards becoming politicians they sold their souls to the idea of Public Relations. In this instance that means that if you think you may have to reduce interest-rates later in 2023 tell everyone first about your plans to raise them. That is the road on which the Fed’s biggest “Dove” has become an apparent “Hawk”
Meanwhile if we switch to the real world we see that 2023 has started with evidence going the other way. Inflation numbers have fallen, as has the price of crude oil, China is struggling, and a mild winter in Europe has meant gas prices not as high as feared. That is why the US ten-year yield is 3.7% because it is looking ahead of the next rise ( presumably 0.25%) to what happens next?