Friday, October 10, 2014

Council on Foreign Relations Economist: Fed Members "Mucking with Unemployment Estimates to Justify Their Positions"

Benn Steil, Director of International Economics at the Council on Foreign Relations and author of  The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, writes at CFR with Dinah Walker:

Do Fed doves and hawks get their aviary classifications based on their cold, hard analysis of data, or is it the reverse – do they select data points to justify their dovish or hawkish perspectives?

The history of the Fed’s post-crisis focus on unemployment suggests the latter.  After June of 2013, as the figure above shows, the Fed’s estimate of the natural long-term unemployment rate begins declining in sync with the decline in the actual unemployment rate.  This suggests that FOMC members are lowering their estimates of the natural rate of unemployment to justify keeping interest rates at zero longer than they could if they stuck by their initial estimates, the 6% consensus upper bound of which is now above today’s actual 5.9% rate.
Steil and Walker conclude:
Our observations suggest that monetary dovishness and hawkishness are often fixed states of mind, rather than artifacts of a consistent approach to data analysis.  If so, there is reason to fear that the Fed’s exit from monetary accommodation will be too late and too tepid – with the result being higher future inflation than the market is pricing in right now.
I have come to the same conclusion about the Fed from the price inflation perspective. For example, in recent ALERTs I have written:
I believe that price inflation is already at the Fed's target of 2% and that the acceleration in price inflation will at some point will intensify very rapidly....I don't think they will react at all until price inflation, by their measures, is at 3%---and at that point the action from the Fed will be too little too late.
Exact timing is, of course, always extremely difficult, but all the elements are in place and I believe once it starts to accelerate the price inflation rate will climb very quickly. First to 3%, then 5%, with the Fed very slow in reacting and ultimately doing too little too late to put a cap on the price inflation growth. They will raise interest rates but nowhere near enough to put out the price inflation fire.

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