Dollars and Jens
Tuesday, March 04, 2008
pushing on a string
The CBOT fed funds futures are increasingly anticipating another 75bp cut from the fed two weeks from now, and I'm increasingly of the belief that that would be the wrong course for them to take. I would like to see the fed hold rates at 3% for about a year or a year and a half and then start raising them, though this, naturally, is based on a set of expectations for the economy that may or may not come to pass.
I sang the praises of Richard Fisher a few weeks ago, and today he explains (indirectly) his dissent from the last fed funds cut, issuing a bearish prognosis for the economy but also for inflation; inflation has, says conventional wisdom, been held down by globalization for the past several years, but Fisher suggests that it also means that demand weakening in the United States may not be enough to reduce prices of globally traded goods and services. I think I'm slightly more bearish than Fisher — I think we're already in a recession, and that general weakness is going to drag on for a while — and I wouldn't argue too strongly against another 25 or 50 bp from here. There are those who think the economic weakness will ipso facto bring core inflation back down; others believe there is some temporary inflation passing through from food and energy to core inflation that will abate of its own accord if food and energy reverse themselves, implicitly suggesting a measure of core inflation that would subtract a multiple of food and energy from the headline rate. These each have elements of plausibility to them, though the second of them is nearly the opposite of what conventional wisdom has held, and, as Bill Poole recently commented, food and energy prices may be volatile, but we may also be in a secular period in which their prices will persistently outrun core inflation. These being particularly tradable goods, this takes us back to Fisher's point.
My concern at this point, notwithstanding Fisher's comment that "a temporary economic slowdown [may be] what we must endure while we [contain inflation]", is that this is one of those places where macroeconomics takes itself too seriously. The U.S. economy is going through a needed realignment in its productive capacities; while I am absolutely certain we are seeing a drop in demand as well, no amount of demand stimulus is going to enable the economy to be more productive than it can be. Some of the "unutilized capacity" in the economy is simply still geared toward production of things that aren't worth what their prices were two years ago. Monetary policy, of course, can't produce things; in most contexts it will feed into decisions, economy-wide, as to what gets produced and what gets consumed, and it plays a valuable role there, but it is not necessarily the case that, for any state of the economy, enough monetary ease will prevent a recession. (In some sense, though these are usually terms applied to the long run, "potential growth" may be negative, and a recession may not imply an "output gap".) I think the fed will have a role in helping the economy make the adjustments it needs to make, but the fed funds target, at this point, has played most of the role it can play; economic weakness will be with us for a while, like it or not, and dropping the target below 2% is simply going to sow the seeds from which we last reaped the seventies.
Update: It's not all that often that, this soon after I post something that I feel is contradicting conventional assumptions in this way, I see almost exactly the same point somewhere else.