The Fed's Stupidity is Still Well Anchored

Mish

Fed Vice Chair Richard H. Clarida gave a speech today touting the Fed's new framework.

Alleged Robust Evolution

A Non-Robust and Painfully Slow Evolution

Please consider A Robust Evolution by Richard Clarida.

Self-Serving Praise

As my FOMC colleagues and I indicated from the outset, the fact that the Federal Reserve System chose to conduct this review does not indicate that we believed we have been poorly served by the framework in place since 2012. Indeed, I would argue that over the past eight years, the framework served us well.

Three major bubbles of increasing amplitude and three severe recessions is not worthy of self-praise.

Phillips Curve Yet Again

Perhaps the most significant change since 2012 in our understanding of the economy is our reassessment of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates. 

Two other, related developments that have also become more evident than they appeared in 2012 are that price inflation seems less responsive to resource slack, and also, that estimates of resource slack based on historically estimated price Phillips curve relationships are less reliable and subject to more material revision than was once commonly believed.

The Phillips Curve, an economic model developed by A. W. Phillips, purports that inflation and unemployment have a stable and inverse relationship.

Simply put, as unemployment falls, consumer price inflation rises.

This has been a fundamental guiding economic theory used by the Fed for decades to set interest rates.

Former Fed chairs Janet Yellen and Ben Bernanke were both big Phillips Curve advocates despite the fact the theory never worked even according to Fed studies.

The Phillips Curve isn't dead, it was never alive to begin with.

The Fed may finally grasp the notion that it based decades of policy on a concept that never worked.

But to mask over that idea, it gave itself fake praise.

Inflation, Uncertainty, and Monetary Policy

Please consider this snip from Inflation, Uncertainty, and Monetary Policy by then Fed Chair Janet Yellen on September 26, 2017.

In standard economic models, inflation expectations are an important determinant of actual inflation because, in deciding how much to adjust wages for individual jobs and prices of goods and services at a particular time, firms take into account the rate of overall inflation they expect to prevail in the future.

Clarida on Inflation Expectation

With that flashback out of the way, let's return to the more folly from Clarida on inflation expectations.

With regard to inflation expectations, there is broad agreement among academics and policymakers that achieving price stability on a sustainable basis requires that inflation expectations be well anchored at the rate of inflation consistent with the price-stability goal. This is especially true in the world that prevails today, with flat Phillips curves in which the primary determinant of actual inflation is expected inflation.

Inflation Expectation Nonsense

While finally admitting that the Phillips Curve is useless, the Fed shifted its focus to yet another totally bogus and easily disproved concept. 

To understand why let's review the CPI makeup.

CPI Percentage Weights2

Inflation Expectations Q&A

Q: If consumers think the price of food will drop, will they stop eating?
Q: If consumers think the price of food will rise, will they eat twice as much or buy more than their freezer or pantry will hold?
Q: If consumers think the price of natural gas will drop, will they stop heating their homes and stop cooking to wait for the event.
Q:If consumers think the price of gas will rise, can they do anything about it other than fill up their tank more frequently?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens?
Q: If consumers think the price of rent will rise, will they rent two apartments to take advantage?
Q: If people need an operation, will they hold off if they think prices might drop next month?
Q: If people need an operation, will they have two operations if they expect the price will go up?
Q: Will people stop paying their monthly phone bill if they believe a better deal might be available next year?

Housing, medical care, gasoline, food, auto repairs are all inelastic items. People will buy those those things and more at a steady pace no matter what their inflation expectations might be. 

Even clothes are mostly inelastic. If someone needs a coat they generally will buy one and they won't buy another even if they expect prices will go up. 

Yes, people shop sales, but they also don't hold off buying computers even though the price-performance ratio drops every year.

CPI a Flawed Measure

Moreover, the notion that one can measure inflation by the CPI is itself extremely flawed.

Ask anyone buying their own health insurance or paying college tuition about their measure of inflation.

Stupidity Still Well Anchored

The only thing that’s “well anchored” is the stupidity of the belief that inflation expectations matter.

Asset Irony

People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices will go down.

People will buy houses to rent or fix up if they think home prices will rise. They will hold off housing speculation if they expect prices will drop.

The very things where expectations do matter are the very things the Fed and mainstream media ignore.

BIS Deflation Study

The BIS did a historical study and found routine deflation was not any problem at all.

"Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Mish

Comments (27)
No. 1-18
Sechel
Sechel

Instead of the Philips curve the should call it the Lazarus curve

Carl_R
Carl_R

In 1968, Milton Friedman said that the Phillips Curve was impossible, except in the very short term. Friedman was proven right, and the Phillips Curve advocates wrong, when inflation and unemployment rose at the same time during the 1970's, something the Phillips Curve said couldn't happen.

Tony Bennett
Tony Bennett

"With regard to inflation expectations, there is broad agreement among academics and policymakers that achieving price stability on a sustainable basis requires that inflation expectations be well anchored at the rate of inflation consistent with the price-stability goal. This is especially true in the world that prevails today, with flat Phillips curves in which the primary determinant of actual inflation is expected inflation"

...

What a clod.

First thing first. "Price-stability goal"? Code for 2% inflation. How does that equate with stable prices. They must have a different dictionary than I.

As usual, nary (EVER) a word on massive debt overhang. Government / Business / Household ALL at record level of debt. There will be NO sustained inflationary until pay down / write down / write off occurs on large scale ... no matter how much formulae BS Federal Reserve officials spew.

PecuniaNonOlet
PecuniaNonOlet

Sounds like indoctrination into something that doesnt work, where have I seen that before...

Jojo
Jojo

Something on the Phillips curve:

Hidden figures
Why does low unemployment no longer lift inflation?
The Phillips curve, the logic of which guides central banks today, has become oddly flat
Aug 22, 2020

Jojo
Jojo

I like this idea! Give ME money, instead of the big banks. I promise to spend it.

Mr. Powell, If You Want Higher Inflation, Give People Money
Aug 29, 2020
OPINION
Frances Coppola

silverdog148
silverdog148

I realize this is your schtick , but even you have to realize all this fed stuff is laughable at this point, this stuff isn't said with any seriousness.

They are ****** in the **** while you report on it.

55AJS
55AJS

Very well put. The FED like most institutions propped up by government has no clue of reality.

Maximus_Minimus
Maximus_Minimus

I have been wondering what guides these *******, because they clearly do not lack self confidence.
Clearly, it's grand delusion, capitulation of common sense, and belief that their academic BS actually works in the real world.
Inbreeding is a problem, and they don't want to change that.

RonJ
RonJ

"Perhaps the most significant change since 2012 in our understanding of the economy is our reassessment of the neutral real interest rate, r*, that, over the longer run, is consistent with our maximum-employment and price-stability mandates."

The fake mandate. It is the stopped clock that is correct twice a day, without any effort.

It is like that ancient guy who pushed the rock up the hill, only to have it roll back down the hill every time he got near the top. It is a worthless mandate. Seldom is there maximum employment.

The FED's price stability is the frog in warm water, with the temperature rising 2 degrees at a time, so it won't realize how hot the water is getting.

Vigorish
Vigorish

Powell, are you pondering what I'm pondering ?

Yes, I think so, Brain, two sock puppets can definitely do that on the floor of the NASDAQ.

Curious-Cat
Curious-Cat

If it were possible for the FED to create general inflation, why has it not done so over the past 10 years - other than inflation in assets?

Seems like this is a narrative designed to give us common folks the illusion that the economy is safe and under control.

Captain Ahab
Captain Ahab

At high unemployment, employers hire productive employees at lower salaries. At low unemployment, employers hire less-productive employees at higher salaries. Overtime also increases. The effect is increasing marginal cost of production.
Now from the consumer side.
At high unemployment, consumer demand is marginally lower and the cost of goods is also lower. As employment increases, consumer demand marginally increases. We'll see prices inflate, or the infamous decrease in 'size' or add-on services.
The complicating factor is trade.
Given the above, all the Fed can do is screw up the competitive market system and exacerbate normal economic cycles.

Herkie
Herkie

Fed pledges to focus on low unemployment and tolerate higher inflation.

Okay, let's parse this new "mandate" the Fed is about to embark upon.

Focus on low unemployment = more work.
Tolerate higher inflation = less buying power for your paychecks.

So, more work less money.

Sounds like the last 50 years to me.

By the way, if there is ANY social security COLA in 2021 it will be small, less than one percent and the consensus seems to be about 0.3% in a time when prices especially for food have gone totally ballistic. I mean eight buck for the greasiest hamburger I have ever seen, $26.99 per pound for salmon, produce when it is available is IF YOU HAVE TO ASK YOU CAN'T AFFORD IT.

Casual_Observer
Casual_Observer

Capitalism has failed.

ColoradoAccountant
ColoradoAccountant

I have a license from the state to practice my trade. The woman who cuts my hair has a license too. I can be sued for malfeasance. I can be ousted for breaking the code of ethics. Economists can't be sued for being wrong, nor ousted for believing in stupid models that don't work in practice. Why do we listen to them?

Vigorish
Vigorish

BREAKING NEWS: Preliminary reports out of Chicago suggest definite economic positives from negative factors travelling backward in time.

Herkie
Herkie

Well I don't know about where you are but it is payday here and so of course gasoline was up 13 cents per gallon, which is 6.3% in one day, and there is nothing in the commodities markets that would account for any increase at all.

Owner's equivalent rents. What a F^ing joke, people who own houses do not watch on tinterhooks the rental prices in their neighborhoods, you know just in case any day they might have to be renters, or rent their houses out. They have no stinking idea what a fair rent for their house would be.

I was actually thinking about macroeconomics and inflation on my way home from shopping.

So the economy was hit for nearly a third of GDP they will admit to. And mind you if I remember right government expeditures add to GDP do they not? So all that stimulus softened the GDP blow. It actually is worse than they will admit to.

Now, one of the first things we learned in business school is that all economics happens on the margin. Like a grocer who operates on razor thin profits, a margin of about 1.5-2% on average. Meaning they can only lose 1.5-2% of their business/customers and they are just breaking even but no profits.

The macro economy is the same way, a certain level of business is required to MAINTAIN business and meet all expenses till they get to the breakeven point. All profit comes after that. A few industries make fairly large profits but only a very few, almost all illegal plus movie theater popcorn manufacturers, ever make anything like 30% profits on a sustained basis.

So, you take away a full third of business and nearly ALL businesses are going to be operating at a loss. Some cannot charge enough more to make that breakeven point in order to survive and they fold, if not now very soon. The smart ones know they cannot operate at a loss long and have already called it quits because they know every business day they are getting deeper and deeper into debt.

Can they CUT prices and sell more? Maybe for a very short period but this only cuts into future demand. Generating more foot traffic is pointless if you cut the prices below the breakeven point, selling goods at a price that represents a loss is not going to save them.

No, if they are going to stay in business about all they can do is raise prices to the point that they are at least breaking even. Some more some less but almost nobody can avoid raising prices in an ongoing crisis where overall business is so far down.

One of two things must happen, ether they get profitable through prices charged or they stop doing business. If you have half the customers you used to have you must charge quite a lot more. That is something called INFLATION!

The problem with that is of course that nearly all people have only so much they can spend, it is the national income pie that has to be divided among all income earners and of course most of it goes to the leeches on Wall Street so very little is left for us to support the remaining businesses. If prices for necessities like today's gas price increase keep rising then by economic law we have to pay it, meaning there is less to support our local haircutter, yard mower, pool service, etc.

I am seriously considering having my lawn cut every three weeks instead of every other Monday. The HOA will howl, and my neighbors might not like it, but I see the best guess for the 2021 COLA is zero to 0.3%, not even a third of one percent, while my costs this year for just basics has gone up MORE than 10% overall, and gorceries in the region of 20% (when you can even get them for shelves being empty STILL). Therefore that increase has to come out of what is available to spen for other items.

This is as you can see a vicious self feeding collapse. You cannot cure it via more stimulus except in the very short run before that also causes more inflation still. A healthy dose of income redistribution from top down would work, but more than half the country will suffer some. This Covid depression is the trigger for a socialist UBI that will not be either fair or even, certainly not uninversal so they should not call it UBI but rather a wage support. In effect a minimum wage increase supported not by goveernment mandated increases in wages to labor, but directly from the treasury itself. Meanwhile that puts me and other veterans at the very bottom of the economic pile of dog feces. As our COLAs go nowhere year after year after year.

At least I no longer live in California where yesterday they appointed a commission to say how much slave reparations black people will get, even though the state was never a slave state. So they opened that can of worms. They can pay reparations to everyone they discriminated against with laws that for example discriminated against citizens who were gay, female, immigrants, and let's not forget Native Americans. So how much could a Canadian indian lesbian get? Talk about ticking all the boxes. (TICKING NOT TICKLING, get your mind out of the gutter).


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