Is Fed policy too easy or too tight?
By Scott Sumner
Now that the Fed is gradually raising interest rates, there’s a lot of discussion of whether policy is too easy or too tight. I don’t have strong views either way on this question, as current policy seems reasonably appropriate to me. But I also thought it might be useful to sketch out a few reasons why I’m fairly content, relative to some other observers.
1. Some people take a “Phillips Curve” perspective, and argue that tight labor markets will lead to higher inflation. The current low rate of wage growth is viewed as a sort of mystery, given the very low rate of unemployment. In my view there is no mystery at all, as wage growth is determined largely by NGDP growth, not the tightness of labor markets. TIPS spreads still don’t show much risk of higher inflation.
2. At the other extreme, some people worry that a falling yield spread, i.e. a flattening yield curve, indicates that the risk of recession is rising. Here it’s important to note that the current yield spread does not forecast a recession, and even if the yield curve were to become completely flat there would still be less than a 50% chance of recession over the next 12 months. Instead, the flattening yield curve should be seen as an indication that NGDP growth is likely to gradually slow over time, as is appropriate if the Fed is serious about its 2% inflation target.
BTW, the reason I expect growth to slow is that the unemployment rate will probably stop declining within the next 12 months. That will slow RGDP growth. If the Fed wants to keep inflation at 2%, they’ll need to also slow NGDP growth.
3. While the yield curve forecasts better than most other indicators, I believe the Hypermind NGDP market is the best single predictor of the future path of NGDP growth. That market shows NGDP growth running at about 4.5% from 2018:Q1 to 2019:Q1. If you don’t like that market, the consensus view of private sector forecasters is closer to 4.8%. We don’t yet have a NGDP futures market for 2019-20; my hunch is that it would show about 4.0% growth, if such a market were created.
PS. Speaking of NGDP futures markets, I hope to soon be able to report some information on that score, which may augur improved prospects of NGDP futures targeting at some point in the future.