Is the Fed beginning to see the light?
By Scott Sumner
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.)