David Beckworth directed me to an interesting post by Tim Duy:
Most likely, net job growth will continue even if at a slower pace. That job growth will be sufficient to drive income growth, and income growth will support consumption. But what about the missing fiscal stimulus, you say? I know this will be widely hated, but the decline in spending in nominal and real terms at this point pretty much matches the decline in income excluding current transfer payments . . .
The fall in consumption exceeded the fall in incomes early in the cycle while, on net, transfer payments are ending up as forced saving. The virus is the key impediment to growth at this point; there are certain sectors of the economy, leisure and hospitality in particular, with limited prospects until the virus is under greater control. There isn’t really a debate on this point; there is simply a nontrivial supply-side constraint on the economy right now.
I don’t hate Tim Duy for saying that the key problem now is on the supply side, as I’ve also been making that argument. That’s not to say that demand stimulus would have no value right now—both Duy and I would prefer somewhat higher inflation expectations—but this isn’t the main factor currently holding back the recovery.
Some people complain that the Fed’s new “average inflation targeting” policy is quite vague and ambiguous. That’s true, but in an earlier blog post I argued that as a practical matter it is pretty clear what the Fed intends to do. Duy linked to a speech by Chicago Fed president Charles Evans that confirms my prediction:
Forget the many years of underrunning 2 percent since 2008, and let’s just start averaging beginning with the price level in the first quarter of 2020. Core PCE inflation in the SEP is projected to be 1-1/12 percent this year and then gradually rise to 2 percent in 2023.12 Suppose it hits 2-1/4 percent in 2024 and then stays there. In this scenario, cumulative average core inflation starting from the first quarter of 2020 does not reach 2 percent until mid-2026. That is a long time. If you can produce 2-1/2 percent inflation in 2024, you can get there about a year quicker.
That was my view as well, that the Fed would start the clock at the beginning of 2020 and begin to push inflation a few tenths of percent above 2.0% in 2024, until the near-term inflation undershoot was offset. I don’t think there’s much doubt any longer as to what the Fed intends to do. The only question now is whether they will do what they promise or renege on their promise. We’ll probably know the answer by 2025.
READER COMMENTS
marcus nunes
Oct 6 2020 at 9:47pm
Fed is already reneging on the promise!
Michael Sandifer
Oct 7 2020 at 1:10am
Market reactions seem to clearly signal that some fiscal support is needed. That doesn’t some of the $2.4 trillion the Democrats want to spend won’t be wasteful, but it’s a mistake to pass no stimulus bill.
dlr
Oct 7 2020 at 7:22am
i am also curious what you think about the market’s clear preference for more and sooner stimulus based on every breaking rumor reaction since summer. and the reactions aren’t just about favored children like airline stocks, they are widespread in equities, volatility indices and real rates up the curve. when it comes to mon pol surprised you typically take market reactions as informative.
Scott Sumner
Oct 7 2020 at 11:40am
It’s hard to say, as TIPS spreads did not fall on yesterday’s news.
I wouldn’t rule out fiscal stimulus having some positive impact on profits. Again, this is why we need a good NGDP futures market.
Thomas Hutcheson
Oct 7 2020 at 8:11am
If steady NGDP is what we want we want, why shouldn’t inflation be higher initially with tapering off as supply constraints erode? [Isn’t it a mistake to count reduction in demand for indoor dining as a SUPPLY constraint?]
Fiscal policy should focus on relieving distress of unemployment and lost of revenues (individuals and states and local governments cannot borrow to optimally smooth their consumption/investment trajectories) and for investments in activities like mass testing that prevent spread of the virus and or reduce the costs of infection.
Scott Sumner
Oct 7 2020 at 11:41am
I agree, inflation should be countercyclical.
Michael Sandifer
Oct 7 2020 at 10:29am
This is a situation in which we can’t simply take stock market reactions at face value, because what Wall Street wants and what the economy needs are not necessarily the same thing in this case. It’s not necessarily bad to let some large businesses fail, for example.
But, we don’t want falling inflation expectations, and although what fiscal policy can do about that is very limited, only really applying to the next year or two, it is nonetheless important not to let state and local government spending fall too much during a pandemic and there are individuals here and there who still need help.
The kind of fiscal support needed can’t move liquid assets markets all that much, but the effects will nonetheless be noticeable.
Monetary policy does in fact have limits during this pandemic, as outlined here before, since both supply and demand are limited by real factors.
Michael Pettengill
Oct 8 2020 at 12:11pm
Inflation is running hot. But the supply is constrained by greed. There are few Elon Musk’s working hard to increase supply of shares of stock to fund building lots more and bigger factories.
Why economists don’t see the inflation is baffling to me. When factories and other assets are priced far above the labor cost of a new and better one, you have inflation.
And in a global market, the factories will be built. By China, or maybe Germany, or Musk and Bezos, but not by followers of Milton Friedman.
On Frontline, one part of the story was the “mask” maker who couldn’t compete with China because he relied on China for raw materials. China does what US industry did until the 70s, and Musk does now: build and scale as much of the supply chain to cut unit costs. Musk is going to go into mining because that’s the only way to ensure supply and cut unit costs. By owning the entire supply chain, China’s multiple firms’ cost/price are half a small US producer. Just as Tesla has driven down battery costs well below everyone else.
Stock prices are way too high, ie inflated.
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