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Joey vs. the Fed

ResponsiblyIrresponsible
Posts: 12,398
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6/24/2015 12:20:42 AM
Posted: 1 year ago
Yup, that title foreshadows a post far more than ominous than what actually will come. No worries: I'm not taking down Janet Yellen and friends yet. After they raise rates (i.e., in September, per all reasonable estimates), you'll see a rant on how utterly incompetent they are, how utterly deplorable their forecasts are, how piss-poor their risk calculus is, et al. But that's not the case now, so you can put aside your popcorn. There's still a chance, however small, that Charlie Evans will prevail (yes, a probability of .000000000001% is still a chance).

So, I've been looking at some data recently - and, by that, I mean that I was decomposing the Fed's last three SEP's (Summary of Economic Projections). There's loads of good stuff in there, including forecasts for RGDP, headline and core inflation (and thus you can back out nominal), unemployment, and perhaps most importantly, median FFR projections. The dot plot required a magnifying glass - and 20/20 vision - to actually read, and subsequently a lot of quality time with a spreadsheet, but no worries: I've done that for you. Aren't I just the most benevolent villain you've ever e-met?

But there's more to the SEP than just these forecasts, most of which have been embarrassingly wrong over recent years. Case in point, the Fed has overestimated RGDP growth and underestimated employment growth, suggesting underlying secular trends in productivity that can't be readily explained in a New Keynesian model. But I read a piece by Tim Duy, a noted economist out of the University of Oregon who writes this very reputable blog called "Fed Watch," that got me thinking (linked below).

He basically backed out estimates of the market-clearing, Wicksellian equilibrium real interest rate which presently stands at the very heart of when the Fed will tighten policy. The implication is that the depth of the recession, ongoing headwinds, and structural and demographic factors have pushed that rate considerably lower than it has been historically. Tim went further than I did in actually plotting the policy rate through 1993 and 1999 Taylor Rules (the difference being that the 1993 rule uses deviations of log real GDP from log potential real GDP and the 1999 variant uses unemployment slack) alongside the median SEP projections, though I'm not going to do that because (a) I'm lazy and (b) I think the Taylor Rule is a sack of bullsh1t on par with the IS-LM model (that I derived mathematically a few days, btw).

Anyway, Tim inspired me, so here you go (2020 corresponds to the "longer run," though really, in the context of the SEP, that means 2018 onward):

http://oi60.tinypic.com...

I plotted median, end-of-year FFR projections alongside projections of the Wicksellian real rate for the three latest SEP's: December 2014, March 2015, and June 2015. The numbers are a tad hard to see, so I'll mark down the most important ones - namely of the equilibrium real rate (note that I excluded 2014 because it appears only in the December SEP):

December 2014 Projections

2015: -0.175%
2016: 0.7125%
2017: 1.7875%
Longer Run: 1.75%

March 2015 Projections

2015: -0.075%
2016: 0.075%
2017: 1.175%
Longer Run: 1.75%

June 2015 Projections

2015: -0.075%
2016: -0.125%
2017: 0.925%
Longer Run: 1.75%

So, what do we see? Well, that depends on what you're looking at: we see a long-term equilibrium real rate of 1.75%, relative to the historical average of 2%, but that need not mean anything: maybe Ken Rogoff is right, and once headwinds wear off, we'll be looking at 3% trend growth and a 2% equilibrium real rate. i think the Fed expects that as well. This sets up a clear demarcation between the "optimists," let's call them, and others like Larry Summers, Paul Krugman, John Williams himself (though he'd probably deny it now), and me: we're not nearly as optimistic as to the long-run trend level of growth. It's telling that, while the Fed has revised down its near- and medium-term forecasts for the equilibrium real rate, the long-run forecast has remained constant at 1.75%.

And the reason for this title is that I made a post about a month back predicting that this real rate was in fact 0%, corresponding to a nominal equilibrium interest rate of not 3.75%, but 2%, which obviously reignites the problem of the two zeroes - the constraint of the zero lower bound on nominal interest rates and downward nominal wage rigidity - and, much to Krugman's delight, enhances the case for a 4% inflation target.

So this is another thread for me to document my predictions: the Fed will raise rates in September, the medium- and near-term forecasts for the real rate will fall, prompting them to hold the FFR where it is. Over time, they'll realize that even their currently decelerating trajectory for the FFR is far too hawkish, and revise it down further, only to realize - perhaps two years out - that the long-run rate has fallen as well. Consequently, their estimate of both trend - much of which is self-fulfilling and self-reinforcing, mind you, though we've probably hit a cap on that (hysteresis, that is, since vacancies have already hit an all-time high) or soon will - and the equilibrium real rate prevailing over the longer run will plummet. Eventually, I think they'll concede that the rate is in fact 0%.

Thus ends Episode 1 of "Joey vs. the Fed." Stay tuned, folks.

Tim's post: http://economistsview.typepad.com...
December 2014 SEP: http://www.federalreserve.gov...
March 2015 SEP: http://www.federalreserve.gov...
June 2015 SEP: http://www.federalreserve.gov...
~ResponsiblyIrresponsible

DDO's Economics Messiah
16kadams
Posts: 10,497
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6/24/2015 12:30:14 AM
Posted: 1 year ago
Vote Rand Paul

End the Fed
https://www.youtube.com...
https://rekonomics.wordpress.com...
"A trend is a trend, but the question is, will it bend? Will it alter its course through some unforeseen force and come to a premature end?" -- Alec Cairncross
ResponsiblyIrresponsible
Posts: 12,398
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6/24/2015 12:31:26 AM
Posted: 1 year ago
At 6/24/2015 12:30:14 AM, 16kadams wrote:
Vote Rand Paul

End the Fed

^ This.
~ResponsiblyIrresponsible

DDO's Economics Messiah
16kadams
Posts: 10,497
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6/24/2015 12:32:40 AM
Posted: 1 year ago
At 6/24/2015 12:31:26 AM, ResponsiblyIrresponsible wrote:
At 6/24/2015 12:30:14 AM, 16kadams wrote:
Vote Rand Paul

End the Fed

^ This.

Well... ending the fed wont work. Illuminati commies will make a second one.

END THE REDS
https://www.youtube.com...
https://rekonomics.wordpress.com...
"A trend is a trend, but the question is, will it bend? Will it alter its course through some unforeseen force and come to a premature end?" -- Alec Cairncross
ResponsiblyIrresponsible
Posts: 12,398
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6/24/2015 12:33:51 AM
Posted: 1 year ago
At 6/24/2015 12:32:40 AM, 16kadams wrote:
At 6/24/2015 12:31:26 AM, ResponsiblyIrresponsible wrote:
At 6/24/2015 12:30:14 AM, 16kadams wrote:
Vote Rand Paul

End the Fed

^ This.

Well... ending the fed wont work. Illuminati commies will make a second one.

Not if we cut off their funding source: nationalize the oil and *then* end the Fed.

END THE REDS

Those too. Heck, don't even get me started on those guys... they're worse than the DDO Elite.
~ResponsiblyIrresponsible

DDO's Economics Messiah