Fitty Ways to Hike Your Funds Rate
MELBOURNE, Fla. -- What do we know now that we did not know yesterday?
We know that the pace of increase in the
Producer Price Index
for finished goods
blipped down in April (see the chart on our
We know that the pace of increase in the core (excluding food and energy) finished goods index accelerated for a third straight month; it was rising at a 1.3% year-on-year rate in April against a 0.8% rate in January. This follows a stair-step deceleration that began in January 1999 (again see
We know that the core intermediate goods index preserved for a 14th straight month the uptrend on which it embarked in February 1999. It was falling at a 1.8% year-on-year rate then; it is rising at a 3.3% rate now.
We know that the pace of change in the core crude goods index has recently leveled out following a marked runup that began in December 1998 (when it was falling at a 16.0% rate). Its year-on-year increase has now clocked in between 15.4% and 16.9% for four months running.
Now consider what we know about the past.
We know that during the last tightening cycle, the year-on-year increase in the finished goods index never exceeded 1.7%; compare that to 3.9% now. We know that during the last tightening cycle, the year-on-year increase in the core finished goods index got as high as 2.0%; compare that to 1.3% now. We know that during the last tightening cycle, the year-on-year increase in the core intermediate goods index got as high as 7.1%; compare that to 3.3% now. We know that during the last tightening cycle, the year-on-year increase in the core crude goods index got as high as 17.7%; compare that to 15.4% now.
We also know that during the last tightening cycle, the year-on-year increase in the core
Consumer Price Index
got as high as 3.0%; compare that to 2.4% now. We also know that during the last tightening cycle, the year-on-year increase in the core personal consumption expenditure price
index got as high as 2.6%; compare that to 1.6% now.
In short, we know that the price measures are, on balance, notably kinder now than they were then.
Is this reason to believe that interest-rate increases will necessarily prove notably kinder this time around, too?
Your correspondent answers in the negative. For two reasons.
The first is what
policymakers themselves say.
There should be no doubt that output has indeed been increasing at a faster rate than capacity. The evidence is the consistent decline in the unemployment rate. It has declined by about 0.4 percentage point per year over the last four years, with the decline being at least 0.3 percentage point each year. Based on historical regularities, this suggests that output has been growing about 3/4 to 1 percentage point faster than capacity, on average, over this interval. In a recent talk, I reviewed estimates of trend growth in potential output from surveys of professional forecasters and from model-based forecasting firms. These estimates all fell short of the more than 4% average growth rate of real GDP over the past four years and the 4.5% rate over the past two years. In the absence of an appropriate degree of tightening, I believe that this imbalance in the growth of demand and supply would persist.
The last time around, the economy had been growing at a faster rate than capacity for only one year; this time around, it's been doing so for four. That, coupled with a set of financial conditions that policymakers themselves are calling "unusually stimulative" even in the wake of five tightenings, makes me believe that they have much less tolerance for above trend growth (remember that domestic demand is now rising at its strongest pace since the mid 1980s) and for further labor market tightening (remember that the jobless rate sits at its lowest level in 30 years) now than they have had at any point during the last decade.
The second reason is that real rates ought to be higher this time around anyway: That's precisely what we would expect to see in the wake of a five-year, technology-driven investment boom. We touched on this in the column
yesterday, and I got first-rate notes (thanks to Joel Files, a grad school chum and the best fried-chicken maker ever, for the one below) in response.
I kind of wondered whether anyone but me thought that rising productivity implied this. After all, if the returns on capital are going to go up, the time-price of money should go up as the incentive to borrow goes up. You' re the only person I've seen say this in print (or electrons) though. I guess pea-minds think alike.
And interestingly enough, one newspaper reporter discusses this at length in a
piece that appeared today.
Your narrator thinks that today's PPI numbers have no bearing at all on the policy decision that will be handed down next week; further, he thinks central bankers will hike the funds rate by half a percentage point no matter what the CPI prints on Tuesday.
And do keep in mind that he is not always right!!