The Blink in Janet’s Eye

 
janet-yellen

“Are you talking to me?”

In the end, it was no contest. The global markets looked the Fed in the eye, the Fed blinked, and — in so doing — has created the real possibility of higher inflation. The blink showed up in the statement the Fed made at the end of its meetings:

Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.

This is the single most notable change in the Fed’s statement. No real change in labor market outlook was expressed. Yet, when asked about this inflation pressure later, Fed Chair Janet Yellen called these near term pressures “transitory.” This strikes me as a bit too much fine tuning. If you think we’re at full employment and that inflation is likely to return to 2 precent in the medium term — as Yellen says we will — then you don’t need a zero Fed funds rate.

The worse part is that Yellen gave herself permission to join those who want the target inflation rate to be above 2%. In a summary provided by the Wall Street Journal, she responded to a question about whether it will ever hit the target by saying it would do one better:

The reason the Fed is raising rates before inflation hits 2%, she said, is that if they waited they would “likely overshoot substantially our 2% objective and might be faced with having to tighten policy in a way that would be disruptive to the real economy.”

This opens the door to keeping inflation above 2 percent for awhile as the result of being sure we don’t upset global markets disrupt the real economy.

But this is simply a self-fulfilling prophecy. When the Fed chooses to hold off on a rate increase it had telegraphed a month ago, it is saying its information is that the economy is worse than you think. When confidence is dented and GDP falls, the Fed will congratulate itself. When the economy turns around next, the Fed will say it wants to raise rates, and China will get the vapors again, and the blinking returns.

I realize some Ricochetti will disagree when I argue the economy is doing reasonably well. But if you do agree with me, what the Fed does by delay is place itself on the path of a faster upswing in interest rates in 2016. That’s not good for stocks, your house’s value, or the incumbent party in the White House. If you disagree, then the Fed did the right thing … except it’s what they’ve done for the last seven years and look where it’s gotten us.

It’s unlikely third quarter GDP will be up more than 2 percent, which will put off interest rate liftoff to at least December. It is now quite possible that we will ring in 2016 with a big fat zero.

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There are 14 comments.

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  1. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    Given the way inflation has undershot its target over the past seven years, would a short period of overshooting really be a bad thing?  And that’s assuming 2% is the right target; given how much government has exploded during our period in the zero lower bound, I’m not sure a 3% inflation target would be such a bad thing.

    It surely can’t be coincidence that large expansions of government always seem to happen when inflation and nominal interest rates are unusually low.

    • #1
  2. John Penfold Member
    John Penfold
    @IWalton

    The whole thing assumes we know what we’re doing and can control outcomes.  We don’t and we can’t.  Our money is credit based and the money base hasn’t turned into money supply because the economy is flat.  The economy is flat because the government is crushing small business, new business, entrepreneurial activity who do most of the borrowing which would turn the base into money.  The government is able to do this in part because the Fed monetized the debt.   It’s like most things coming out of Washington, insane, wrong, corrupt and the longer we accept it the more difficult to undo.

    • #2
  3. BrentB67 Inactive
    BrentB67
    @BrentB67

    I believe watch what the Fed does, not what it says in this case. The global economy and certain areas of our economy are weaker than a 5-5,5% unemployment rate and declining new jobless claims indicate. I wrote about it in a note to clients yesterday shared on the Member Feed if anyone is interested.

    The problem now is the FOMC is out of bullets for the most part. I had discussions with some astute managers and read their work this summer where they said no raise in rate was a forgone conclusion and they were speculating about the next round of QE.

    • #3
  4. BrentB67 Inactive
    BrentB67
    @BrentB67

    JE, the issue with the inflation >2% is that monetary policy is a blunt instrument with a lag effect. Inflation >2% may required very extreme measures to correct and create fed induced interest rate oscillations that would have disastrous impact with our national debt > GDP and >1/3 of the public held portion financed short term.

    • #4
  5. The Reticulator Member
    The Reticulator
    @TheReticulator

    I favor a zero percent inflation rate like we had, more or less, from the founding until the 1960s.   I note that a lot of the people who say a little inflation would be good aren’t old enough to have lived with inflation that has gotten out of hand.   If you favor a higher inflation rate, let’s hear no more complaining from you about a government that steals from its citizens through confiscatory taxes.

    • #5
  6. The Reticulator Member
    The Reticulator
    @TheReticulator

    John Penfold:The whole thing assumes we know what we’re doing and can control outcomes. We don’t and we can’t. Our money is credit based and the money base hasn’t turned into money supply because the economy is flat. The economy is flat because the government is crushing small business, new business, entrepreneurial activity who do most of the borrowing which would turn the base into money. The government is able to do this in part because the Fed monetized the debt. It’s like most things coming out of Washington, insane, wrong, corrupt and the longer we accept it the more difficult to undo.

    I hope 1000 people each give this the “like” it deserves, because without signing up for more Ricochet accounts for myself I can like it only once.

    • #6
  7. Z in MT Member
    Z in MT
    @ZinMT

    The Fed-US Gov-US Econ is stuck at a local attractor point. The Fed keeps interest rates low to help out the US Gov from going bankrupt, this keeps inflation low because the US Econ is anemic, the US Econ is anemic because the US Gov hoards all the capital, holds down economic expansion through regulatory red tape, keeps confidence low by continually kicking the can down the road on entitlements and the budget and eases the pain for the unemployed through food stamps, health care subsidies, and disability that it pays for with cheap credit subsidized by the Fed.

    Look at what the markets did this morning. If the Fed had raised interest rates to .25% yesterday the market probably would have shot up due to increased confidence.

    • #7
  8. Ward Robles Inactive
    Ward Robles
    @WardRobles

    Thanks for the excellent post. Not enough punditry is focused on these issues. IMHO, this opaque policy area is where most of the mischief by the ruling class is taking place. I keep looking at hockey stick charts of the money supply, and wondering when the other shoe will drop.

    The government engineered a deal in which the big banks and giant government-sponsored entities took on the debt created in the last bubble to burst instead of just facilitating an orderly unwinding of all those bad investments. Too many government pensions were invested in mortgage-backed securities, I guess. In order to make that work, the government had to lend to the banks and entities at essentially zero interest and create fake investments (“excess reserves”) so that the big banks could stay afloat.

    The only reason inflation is not raging is that the excess reserves are not circulating in the economy. Rates are so low, the government-sponsored entities have displace practically all private lending in home mortgages. Housing prices are re-inflating. In my area, prices on apartment buildings have gone asymptotic while wages are stagnate. The economic planners are not going to be able to keep their juggling act going indefinitely. Eventually one ball will drop, and then a bunch will drop. My cynical guess is that the Democratic-appointed Fed members just want it to happen on the watch of the next, probably Republican, president.

    • #8
  9. Z in MT Member
    Z in MT
    @ZinMT

    The biggest macro issue out there right now is the retirement of the baby boomers. The interesting thing about the retirement trend of the baby boomers is that the lower the person’s income the earlier they tend to retire (or try to collect disability). This is causing a severe strain on the SSDI program which will go bankrupt next year.

    The retirement of lower and middle income baby boomers is holding down inflation temporarily as they are being replaced with less experienced (and therefore less expensive) younger workers. Also as they are retiring on small incomes demand is held down.

    • #9
  10. AldenPyle Inactive
    AldenPyle
    @AldenPyle

    I agree with Z in MT that our main economic problems are structural and he has identified the principal ones.  In particular we are still being hit by a deadly combination of a demographic bulge, global headwinds, slow productivity growth, and the inability of our financial system to generate investment despite high asset profits and corporate profits. Some of these could be  addressed with government tax and regulatory policy which emphasized efficiency and market competition ((and would be if Mitt Romney were President). However, none of these structural problems can be solved with monetary policy.

    The best that the Fed can really hope to achieve is to avoid disinflation. In a world with too much savings and not enough investment in productive capital projects, the last thing we need is higher interest rates (nominal or real). The Fed has committed to 2% inflation, if they implement inflation below target, that will act as a surprise transfer from borrowers to lenders, further punishing those people who are building productive capacity.

    • #10
  11. Steve C. Member
    Steve C.
    @user_531302

    John Penfold is closer to truth than most. Notice I didn’t say “the truth”, I think that’s unknowable. If Janet Yellen had some ham and some bread we would have a ham sandwich, or perfect monetary policy. You choose. In many respects the Fed is like the Supreme Court. Part of their influence depends on the mystical manifestations and incantations of their opaque utterances. Is money too tight? Are rates too low? Will the Rangers prevail over the Mariners in spite of Derek Holland’s horrid performance?

    Rule number one is not, do no harm. It’s, never be perceived to have made an error. Ie, play it safe and surround your pronouncements with enough weasel words and bafflegab so that at minimum you can claim you were misunderstood.

    What to do? No idea. Because people at the Fed are human, and government employees I have no expectation they will get it right.

    • #11
  12. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    BrentB67:JE, the issue with the inflation >2% is that monetary policy is a blunt instrument with a lag effect. Inflation >2% may required very extreme measures to correct and create fed induced interest rate oscillations that would have disastrous impact with our national debt > GDP and >1/3 of the public held portion financed short term.

    That depends how it is created.  My offhand comment aside, ideally the inflation target would be raised by an act of Congress (after a long period of public debate), with the expectation that it would be achieved over a period of, say, five years.  With that much lead-in time, inflation expectations should remain fully anchored.

    That said, I just took a quick look at the most recent economic data, and on the surface it certainly does argue for a rate increase.   I’m not sure how much to read into it, though, some of it may just be the oil shock.

    • #12
  13. Joseph Eagar Member
    Joseph Eagar
    @JosephEagar

    Steve C.:What to do? No idea. Because people at the Fed are human, and government employees I have no expectation they will get it right.

    That’s not quite fair.  The Fed is probably the most professionally run organization in the country; the stakes are just too high for it to be anything else.  When Obama tried to give the Fed chairmanship to Larry Summers as a kind of political appointment, the entire political spectrum rose up to stop him.  Everyone just had too much to lose from allowing the Fed to turn into yet another patronage factory.

    • #13
  14. King Banaian Member
    King Banaian
    @KingBanaian

    I agree that I’ve always felt the Fed has excellent professional staff. But as someone who has made study of its independence part of my research agenda, I have been forced to reflect lately if that support is induced by the prospect that my work is influential, gets me access to its favors, etc. “Prospect ” insofar as to date I have received no favors but there’s still time…

    • #14
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