Imagine you were on a ship crossing the ocean. The captain said he hoped to reach New York, but didn’t have any great confidence as to whether the ship would achieve that destination. In contrast, he told you exactly how he planned to adjust the steering wheel over the next 3 hours. How would you feel?
Personally, I’d rather the captain express a high level of confidence as to the destination, but also exhibit a willingness to change the steering wheel setting as necessary to offset wind and waves.
Over the past year, I’ve often been critical of the Fed. The so-called “flexible average inflation target” has ended up creating more confusion than clarity. The exact meaning of the 2% inflation target is now unclear. In 2021, the Fed provided forward guidance on interest rates and QE, leading to a policy that was too expansionary for the conditions of the economy. They should have provided much more clarity about where they wanted the future price level to be, and much more willingness to make interest rate targets and QE be “data dependent”.
Today, I’d like to praise Jay Powell for his comments at yesterday’s press conference. He was forceful in his statements that the Fed would do whatever it takes to get inflation back to 2%. (Of course I’d still prefer NGDP level targeting.) More importantly, he suggested that future interest rate movements would be data dependent. I suspect this is why the markets responded positively to the press conference.
The media often focuses on whether Fed statements are hawkish or dovish. I focus more on whether they are effective in achieving the Fed’s goals and reducing policy uncertainty. By that criterion, yesterday was a modest step forward.
PS. And no, we did not have a recession in the first six months of 2022.
READER COMMENTS
John Hall
Jul 28 2022 at 2:48pm
“I focus more on whether they are effective in achieving the Fed’s goals and reducing policy uncertainty. ”
Five-year and ten-year breakeven inflation rose yesterday during and after the press conference. The dollar also fell. That doesn’t exactly give me a lot of confidence…
TMC
Jul 28 2022 at 3:53pm
“And no, we did not have a recession in the first six months of 2022.”
I think the question is ‘are we in a recession now?’
Scott Sumner
Jul 28 2022 at 7:19pm
That’s a different question. I don’t know the answer.
TMC
Jul 28 2022 at 10:54pm
Fair enough, but that’s the only question anyone cares about. Extremely likely, the answer is Yes. At this point, while you are right about the technical ambiguity, the burden is on you to defy the two quarter ‘rule’. It has been right almost every single time.
Scott Sumner
Jul 29 2022 at 10:48am
You missed my point. The GDP figures suggest we should have been in recession in the first half of the year. But we were not. The two quarters of falling GDP is not a technique for predicting recessions (for that we use things like yield spreads.) It’s a coincident indicator. This time it gave a false reading.
Michael Rulle
Jul 28 2022 at 3:59pm
Bonds up, stocks up. I perhaps naively take that as a good sign and I did like his 2 Percent inflation assertion. Not quite FAIT, but EMH moved up
Rajat
Jul 28 2022 at 4:09pm
I had almost almost the exact same reaction. Bond yields down and stocks up after the GDP report. Looks like the market at least thinks there will be a soft landing.
David Henderson
Jul 28 2022 at 5:14pm
You write:
I’m inclined to agree with you, but that’s because I don’t wait on the NBER to say what those 8 economists think. I’m surprised, though, that you have reached such a categorical conclusion. The gist of your message a few weeks ago, I thought, was that one should go with the NBER’s conclusion.
Scott Sumner
Jul 28 2022 at 7:24pm
“The gist of your message a few weeks ago, I thought, was that one should go with the NBER’s conclusion.”
That’s right. But the monthly data that the NBER relies upon is already available. So if there is a recession at some point later this year, the NBER won’t date it as beginning in early 2022.
BTW, I don’t even believe that real GDP fell in the first half. Probably measurement error.
BC
Jul 29 2022 at 7:44am
“I don’t even believe that real GDP fell in the first half”
Then, why are we having all these “supply chain shortages” if not due to decline in output? Are we running out of baby formula, having too much trouble producing more oil and gas, and waiting so long for plane flights because we are producing too much of something else? If total output has not declined, then what goods and services have seen “excess output” that more than offsets the decline in baby formula production?
Scott Sumner
Jul 29 2022 at 10:50am
The shortages are caused by excessive demand.
Andrew_FL
Jul 28 2022 at 6:30pm
“Get back to 2%” means above 2% for the foreseeable future, and a permanently higher price level relative to trend
Also if the recovery is over and we’re slowing to trend, not contracting, that means GDP is permanently 2% lower than the prior trend.
Scott Sumner
Jul 29 2022 at 10:50am
Yes, and both facts are very bad.
Michael Sandifer
Jul 28 2022 at 9:15pm
I agree that there was no recession in the first half of the year and, sans new real or nominal shocks, there’s no reason to believe we’ll have one at this point. How could there’ve been such strong jobs numbers for the first half of the year if there was a recession?
Mark Z
Jul 29 2022 at 3:26pm
“How could there’ve been such strong jobs numbers for the first half of the year if there was a recession?” That could happen by real wages declining enough to outweigh employment gains.
Richard W. Fulmer
Jul 28 2022 at 11:37pm
GDP numbers are released only monthly are adjusted for several months thereafter. Fed actions may not take effect for months. With so much time between action, feedback, and reaction how would the Fed avoid over-corrections?
Scott Sumner
Jul 29 2022 at 10:51am
They need to target NGDP forecasts, not current NGDP.
David S
Jul 29 2022 at 6:19am
Scott, thank you for this post. Let’s hope Powell and the Board stay the course because it would nice to have a decade of monetary stability.
I wasn’t quite sure what to make of John Cochrane’s recent WSJ op-ed. What evidence does he present that the dollar is under attack because of decades of fiscal profligacy? Is the attack coming from the same speculators who claimed the yen would collapse? How did that turn out?
Scott Sumner
Jul 29 2022 at 10:52am
I think Cochrane puts too much weight on fiscal policy. It’s monetary policy that determines inflation.
MarkLouis
Jul 29 2022 at 9:12am
Curious how you think about “effectiveness.” 5-year inflation expectations have now risen 18bp to 2.8% since the start of Powell’s press conference. Didn’t Powell therefore move the Fed further away from its stated goal?
Scott Sumner
Jul 29 2022 at 11:00am
There’s no question that the inflation situation looks bad in the sort run. At this point, I think the Fed is looking for a soft landing with roughly 2% inflation in a couple years and no recession. That prospect looks a bit brighter than a week ago. (Most of the excessive 5-year inflation forecast is front-loaded to the next two years.)
I’m not happy with Fed policy (I wish they’d stuck with AIT), just a bit less unhappy than a week ago.
MarkLouis
Jul 29 2022 at 11:05am
I see where you are coming from but I cannot fathom the opposite ever taking place: the Fed is far below it’s inflation target, market expectations are that it will never reach its target, and we are pleased when the Fed says “we hope to eventually climb out of deflation within several years and are proceeding in a data-dependent matter.”
Strikes me that there is a fundamental asymmetry here and any targets need to encapsulate that reality (e.g., hitting 4% NGDP means targeting something lower than 4%).
Scott Sumner
Jul 29 2022 at 11:53am
This is exactly why we need AIT. It would impose the necessary discipline. The Fed made a huge mistake in abandoning AIT.
Spencer Bradley Hall
Jul 29 2022 at 10:36am
Jerome Powell doesn’t have a clue. He has destroyed deposit classifications and overstated deposit volumes.
If banks were intermediaries, we wouldn’t have this problem.
Rick
Jul 29 2022 at 1:32pm
I really like all the analogies you have used over the years comparing monetary policy to steering a ship. I think they have been the most helpful.
But I am less optimistic about Powell’s views. Even his best comments about future rate changes being data driven were prefaced by saying “now that we are back to neutral.” How plausible is it that, after a year of almost 10% inflation and an abandonment of FAIT, the neutral rate would be where it was prior to the pandemic? If my ship is blown off course, I don’t have much confidence in a captain who says “but it’s okay, I put the rudder back in the same position it was in when we were last on course. Let’s see what happens before we do anything else.”
Scott Sumner
Jul 29 2022 at 6:57pm
I tune that out—no one knows where “neutral” is.
Bob
Jul 29 2022 at 7:57pm
“He was forceful in his statements that the Fed would do whatever it takes to get inflation back to 2%.”
He dodged the questions about how bad unemployment would have to get before addressing it. He could have taken those opportunities to make it more clear that inflation will take priority.
Scott Sumner
Jul 30 2022 at 2:47pm
He correctly pointed out that there’s no trade-off in the long run.
Michael Rulle
Jul 30 2022 at 1:37pm
“No one knows where neutral is”
That is something I would normally say. Because it is unobservable. But you always talk about “natural” rate of interest (isn’t the “neutral”?)
Now you tune it out? You just wrote an essay that incorporates it
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