Inching closer to a US recession, while Yellen is eager to hike

Today we got the Minutes from the December 15-16 FOMC meeting where the Fed hiked interest rates.  That in itself is not terribly interesting and there is not much news in the Minutes to shock the markets.

Nonetheless it is another day of tightening of US monetary conditions – stronger dollar, lower inflation expectations, lower commodity prices and lower stock markets. But maybe the most alarming set of information comes from the Atlanta Fed that today published a so-called Nowcast for US real GDP growth in Q4 2015 (GNPNow) indicating the US real GDP slowed to just 1% (annualized quarterly growth rate) in Q4.



It is in this environment the Fed continues to signal that more monetary tightening is warranted.

So why is the Fed so hawkish despited very clear signs of continued growth deceleration in the economy and despite the fact that basically all monetary indications that we can think of indicates that monetary policy has become too tight?

To me it we should blame the unholy alliance between those FOMC members that are obsessed with looking at labour market data (to the same extent Arthur Burns was in 1970s) and the macro prudential crowd who worry that the Fed is inflating a bubble (somewhere in some asset market).

Needless to say there are no monetarists on the FOMC and as a consequence the FOMC continues to ignore both the signals from monetary indicators and from the market and as a consequence the risk of a US recession during 2016 (or 2017) continues to rise day-by-day.

PS maybe it is about time to start tracking Google Trends for the trend in Google searches for “recession”.

HT Michael Darda


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Guest post: Yes Lars, inflation is always and everywhere a monetary phenomenon (By Jens Pedersen)

Guest post: Yes Lars, inflation is always and everywhere a monetary phenomenon
By Jens Pedersen

The host of this blog, my good friend and colleague, on a daily basis reminds me “inflation is always and everywhere a monetary phenomenon” – and even more so this week where we have celebrated Milton Friedman’s birthday. I certainly do not need any convincing. On the contrary with this blog post I will present evidence that this is has indeed also been the case during the “The Great Recession”.

Following the general New Keynesian Phillips curve formulation current inflation depends on the expected future inflation and the gap between current output and the natural level of output. If a larger share of prices is adjusted every period then current inflation will depend more strongly on the current output gap and vice versa.

Using the New Keynesian framework it is possible to show that monetary policy during “The Great Recession” has had leverage over the development of prices both in the short run and the long run. Atlanta Fed’s monthly sticky price index will serve helpful in this. The sticky price index basically comprises the price components in the US consumer price index that are adjusted infrequently. Atlanta Fed furthermore publishes a flexible counterpart comprising the components in the US consumer price index that are adjusted frequently.

The first chart below depicts the development in US flexible core price inflation since 2008. I have used the three-month annual inflation rate only to get a smoother trend – it does not affect the main points of the analysis. I have marked seven turning points in the flexible core inflation that coincides with significant monetary policy shocks. 1) ECB surprises with a 0.25 %-point increase in interest rates, 2) Fed launches first round of QE, signals extended period of low rates, other major central bank cuts rates, Fed open dollar swap line, 3) Fed ends dollar swap line, 4) Bernanke mentions QE2, Fed launches QE2, 5) Trichet signals “strong vigilance”, ECB raises the interest rate twice, 6) ECB implements 3 year LTRO, 7) ECB tightens collateral rules.

What this brief analysis shows is that frequently adjusted prices do react to changes in monetary policy. When monetary policy is eased, demand increases and subsequently prices increase and vice versa.

In contrast, sticky price inflation does not only reflect the reaction to current monetary policy shocks, but also the expectations of the future development in demand. If demand is expected to increase then the sticky price inflation will increase as well.

The second chart below illustrates US sticky core price inflation since 2008. What the sticky core price inflation chart shows is that the monetary policy shocks in the end of 2008 (QE1 and extended period language) briefly improved the outlook for the US economy, but it was not before Fed launched QE2 in the second half of 2010 that sticky core inflation started increasing reflecting expectations of increasing demand. The chart further shows that sticky core inflation has started declining since the end of 2011. Hence, recently monetary policy has not done enough to maintain expectations of increasing demand.

The above analysis shows that consumer prices do contain substantial information on the effects of monetary policy. And to sum up, yes Lars, you are certainly right – inflation is always and everywhere a monetary phenomenon!

PS The Flexible and sticky prices series come from Federal Reserve Bank of Atlanta’s Inflation Project.

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