econintersect .com

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.

posted on 08 October 2016

Fed Moves In Mysterious Ways

from Lakshman Achuthan, Co-Founder and Chief Operations Officer of ECRI

Following last December’s rate hike, both the Fed and prominent Wall Street houses expected four or more rate hikes in 2016. In sharp contrast, ECRI stated that the "Fed’s rate hike plans [we]re on a collision course with the economic cycle." By March it was clear that, "with U.S. economic growth sluggish and slowing, and inflation low but rising, the Fed [wa]s faced with… ‘stagflation lite.’"

We understood that the Fed’s approach was rooted in the broken Phillips curve paradigm. And with the jobless rate nearing the Fed’s estimate of the Non-Accelerating Inflation Rate of Unemployment (NAIRU), it was increasingly difficult to justify putting off the December 2015 rate hike. Yet, having failed to implement its 2016 rate hike plans, the Fed now appears to be casting about for a better analytical framework, leaving policy dangerously unmoored.

It is instructive to examine the Fed’s historical tightening thresholds in terms of labor market tightness and underlying inflation pressures. Accordingly, on the vertical axis of the chart, we show the difference between the unemployment rate and the NAIRU, presented on an inverted scale as a measure of labor market tightness used by the Fed. Thus, the lower the actual jobless rate is with respect to the NAIRU, the tighter the labor market is supposed to be. On the horizontal axis we present ECRI’s U.S. Future Inflation Gauge (USFIG), a more direct measure of underlying inflation pressures. While the red squares show the degree of labor market tightness and underlying inflation pressures at the beginning of the three prior Fed rate hike cycles, the blue dots highlight the change from the December 2015 rate hike to the present.

At the beginning of the1994 rate hike cycle, the NAIRU would indicate the existence of a great deal of labor market slack, but according to the USFIG underlying inflation pressures had already ramped up somewhat. Nevertheless, the Fed started to hike rates, and - although criticized by many because it helped trigger what was, at the time, the worst bear market in the bond market’s six-decade history - it was one of the rare occasions when a preemptive rate hike cycle helped engineer a rare "soft landing." In contrast, in 1999, with the labor market becoming increasingly tight as the unemployment rate slipped below the NAIRU and underlying inflation pressures also building according to the USFIG, the Fed ended up waiting too long, and the rate hike cycle was followed by a hard landing.

In 2004, the NAIRU would have indicated only a modest amount of labor market slack, but the Fed was actually exceptionally late because, according to the USFIG, underlying inflation pressures were substantially elevated. Indeed, it is now widely accepted that the Fed kept rates too low for too long in that cycle, helping to inflate the housing bubble.

In contrast, in December 2015, while the NAIRU indicated even more modest tightness in the labor market, underlying U.S. inflation pressures were far lower than at the start of previous rate hike cycles. Thus, especially given the slowdown in U.S. economic growth that we had flagged in early 2015, the rate hike seemed more driven by the desire to finally get off the zero lower bound. Not surprisingly, with the growth rate cycle downturn worsening as ECRI had predicted, the Fed’s rate hike ambitions were derailed.

Currently, however - while the NAIRU suggests that the labor market are still about as tight as in December, underlying inflation pressures have mounted considerably, according to the USFIG, placing it right within the "triangle" defined by the prevalent conditions at the start of earlier rate hikes, as defined by both the USFIG and the NAIRU-based measure of labor market slack. As a result, the Fed again runs the risk of falling behind the inflation cycle.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted. You can also comment using Facebook directly using he comment block below.

Econintersect Contributors

Print this page or create a PDF file of this page
Print Friendly and PDF

The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.

Keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Middle East / Africa
USA Government

 navigate econintersect .com


Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2018 Econintersect LLC - all rights reserved