Watching Surveillance on Bloomberg this morning there was a discussion about comments Dudley of the NY Fed had made about inflation, something like the lower inflation figures are due to transitory effects and will dissipate, pushing inflation up toward the target sometime next year. While I think the discussion was on the right track, as it was brought up the fact that inflation has been below target for years and the FOMC seems to always find something to explain it away with, if you have at least a basic understanding of how the Fed adjusts short nominal rates and what it means to “reduce the balance sheet,” it’s much easier to get the idea that if the FOMC has any control over inflation at all, the stuff that it has prepared for us in the longer part of the short run will do nothing but further undermine that all so important credibility.
It got me started thinking about math. Because what is somewhat true about what a realistic inflation expectation may be given the plans we know about is also somewhat true about what a realistic expectation of NGDP may be. If I assume that NGDP is growing at a subdued rate, ~ three per cent per annum, and consumer spending is about to take its third hit of the year, so this would be an optimistic number, and inflation expectations are somewhere in the area of one and half per cent, the split would work out to one and a half percent RGDP. Unless we can eek out added RGDP from actual lower inflation readings so the split would be something like one per cent inflation and two per cent RGDP, the near future looks pretty muted.
Then my thoughts wandered to thinking about the opinion piece from our friend Kocherlakota that complained about lack of fiscal support, and wondered about what magnitude of fiscal support could raise NGDP growth enough so that somewhere in the split we would end up with Trump’s RGDP goal of four percent. At first glance it would seem impossible because the supply side would have be reformed enough to cause deflation to the tune of one percent. It may be an oversimplified approach because the FOMC would react to that, and probably not in a beneficial way, but think about the implications at a moment when we can’t even manage to get ObamaCare dealt with. I’d think it nearly impossible even if Trump were to have zero opposition. I’d have to believe in unicorns to think that unless something changed monetarily, we’d get anywhere near four percent RGDP. It isn’t hard to figure out on the back of the envelope ballpark opportunity costs involved with the stuff the FOMC is currently doing and divide it among the 350M some people in the country.
I had some really meandering thoughts, and it then occurred to me that we do way too much thinking in terms of interest rates and inflation, because when we are focused on these, some pretty important points about reality go overlooked and we are more willing to buy the Dudley smoke up the trousers routine when we should be questioning his mental state instead.