Scott Sumner  

Is the Fed beginning to see the light?

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Meta-Crisis... Brad DeLong on Cornucopia...

For years I've been arguing that trend real GDP growth is lower than the Fed believes, that the new normal of interest rates will be lower than the Fed believes, that rates will again fall to zero in future recessions, and that the interest rate policy instrument is therefore pretty useless, like a steering wheel that locks up every time you drive on twisty mountain roads.

I've also claimed that the Fed will eventually figure all of this out. TravisV directed me to a very interesting Tyler Durden post that suggests it's beginning to happen. The Durden post discusses a Goldman Sachs report on the recent release of the minutes of the October 2015 FOMC meeting. Here is Goldman Sachs:

The staff attributed the lower long-run equilibrium rate to a slower rate of potential growth, a consequence of slower population growth and weak productivity growth. These comments might foreshadow another reduction in the median "longer-run" funds rate projection in the Summary of Economic Projections (SEP) in December.


4. Participants also noted that the lower long-run equilibrium rate implies that the near-zero effective lower bound could become binding more frequently. As a result, "several" participants indicated that it would be "prudent" to consider "options for providing additional monetary policy accommodation" should the economic recovery falter.


And here is how Durden summarizes the much longer GS report:

In other words - as the bolded sections highlight -

The Fed is admitting that the neutral rate (to which they will theoretically raise rates before re-easing) will remain lower for longer...

...and therefore will reach ZIRP more frequently going forward...

...which means, as they state, using "additional monetary policy accommodation."

Which means, unless The Fed wants to implement NIRP (which it appears it does not), they will have to do more QE, more frequently going forward...

...basically admitting that the rate manipulation transmission channel is defunct for all intent and purpose.

* * *

So what Goldman discovered was the 'smoking gun' admission that this is no normal recovery and what was once entirely extreme and experimental monetary policy will be the new normal... and that may be why stocks and bonds rallied and why the dollar dropped and gold and crude gained.


The last part about the stock rally yesterday is obviously speculative, but the rest is clearly supported. You might wonder how a lowly blogger could reach these conclusions long before the Fed's outstanding research staff. One reason is that they rely on complex models and I rely on markets. The markets have been telling us that rates will remain lower than the Fed has assumed, and the most likely reason for that is that growth will also be lower than in the past. I would add that I also noticed that RGDP growth has been running at only a bit over 2% the past 6 years, despite the unemployment rate falling precisely in half, from 10.0% in October 2009 to 5.0% in October 2015. The rapidly falling unemployment means that RGDP growth over the past 6 years has been far above the long term trend rate of growth. If the actual growth is just over 2%, just imagine how low the trend rate is today.

Now it's time for the Fed to move toward a new operating system, to replace the obsolete interest rate targeting mechanism. Naturally we market monetarists have some ideas, in case anyone is interested.

(Read Durden's entire post.)



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COMMENTS (9 to date)
TravisV writes:

Readers, please note:

Prof. Sumner strongly disagrees with many of Tyler Durden's views on monetary policy.

P.S.: Peter Schiff was on CNBC's Fast Money yesterday offering more crazy theories.....

Scott Sumner writes:

Travis, Thanks for the link, and for the many other useful links. What would I do without you!

ThomasH writes:

I think it would be better if they stopped worrying about the "proper" level of any one of their instruments (what's special about ST interest rates?) and rather focused on outcomes. The price level is still not back where a 2% inflation target would have it. Maybe getting it right will require lower long term rates or a more devalued exchange rate or lower interests paid on reserves or who know what other instrument they might come up with.

denis writes:

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Plucky writes:

I hate to be "that guy" who points out the obvious, but just in case sumners doesn't know the details

- "Tyler Durden" that makes the posts on zerohedge is widely assumed to be at least 20 or so different people, most of whom are believed to in some way work in finance. Many posts involve screen-grabs from bloomberg terminals, which implies that whoever is using them works somewhere willing to fork over the 18-20k/yr hizzoner insists upon for the service. Everyone on wall street reads zerohedge, only some are willing to admit it.

- the name is a reference to the cult-classic movie "Fight Club" (http://www.imdb.com/title/tt0137523/). Since we're in movie-reference mode, the best way to think of zerohedge is the Mel Gibson movie "Conspiracy Theory", in which the titular crazy conspiracy theorist happens to theorize an actual, real conspiracy but has no clue which of his theories it might be.

- The posts on zerohedge are usually very interesting, but everything there exists within a miasma of nihilism and paranoia. Infowars-level, if not worse. The assumed-to-be-in-finance writers who are Tyler Durden use the site in a quasi-whistleblowing capacity. Everything there should be treated with deep, deep skepticism, but never dismissed out of hand.

- when reading zerohedge, one needs to be razor sharp in the critical-reading department to separate verifiable facts from the aforementioned miasma of nihilism and paranoia

- Being finance-y people in paranoia mode, the Fed is always and everywhere assumed to be essentially a real-life version of the SPECTRE organization from James Bond. Sometimes evil genius, sometimes overconfident blowhard, always and everywhere malevolent. Be advised

Scott Sumner writes:

Thomas, Exactly.

Scott Sumner writes:

Thanks for the info Plucky.

I don't read much in the way of finance blogs, so I wasn't aware of that.

And I always do read with a critical eye.

TF writes:

Scott,
If the bond market really did believe that the Fed was going to implement a policy that would actually work and push NGDP to 5%, which way would long rates go? The answer is certainly not lower as Tyler Durden suggests in his post. Stocks want reduced uncertainty about fed policy, that is why they rallied.

E. Harding writes:

"If the actual growth is just over 2%, just imagine how low the trend rate is today."

-Indeed. I've concluded the U.S. is getting close to the trend rate of unemployment (roughly one percentage point left to go!), so we'll begin to see how the economy really is next year. No doubt it'll be slower than 2014. Will most likely be slower than 2015.

"The answer is certainly not lower as Tyler Durden suggests in his post."

-The effect of tight monetary policy on the real rate is generally larger than that on the inflation premium, at least, in the short-term. This was shown in 2013.

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