Scott Sumner has a new post on The Money Illusion: Don’t look now, but monetary policy is tightening dramatically. It’s saving me some work on this post for the TIPS spreads, as he states in it that they are at 1.46%, roughly equating to 1.15% on the PCE inflation index. If one considers the risk-premium also included, taking it at face value is on the optimistic side; and we have seen about 0.75% worth of rate hikes since the last time they were flashing somewhere within striking distance of the official inflation target. So, it isn’t any wonder then just how we got here.
There is one mistake in Sumner’s post (or at least a shortcut):
In fairness, the latest demand shock came from the renewed trade war, which occurred after the meeting.
Trade wars are supply side phenomena. Demand shocks are generally nominal. A negative supply shock related to trade wars can be translated to a negative demand shock when the central bank doesn’t accommodate the selling that might come with it or tightens policy into it. So it isn’t necessarily wrong, but could be easily misunderstood.
I can’t tell whether policy was intended to be loosened or simply be somewhere near neutral with the 0.25% rate cut last week. But I suspect that policy has been on the slightly tight side since September ’18. The selling episode started in May, before the teenie weenie short nominal rate cut that disappointed, at which time the FX rate for the dollar began to soar and yields declined, and that continues because policy was tight and the tiny morsel tossed out by the FOMC wasn’t enough to right it.
It’s now nearly 100% a nominal problem. When it happens that a negative supply shock get translated into a demand shock by the central bank, guys, I’m sorry; but there isn’t anything here that does or should involve fairness. The guys at the NY Fed and the rest of the FOMC either do their jobs to maintain policy around ~2% PCE inflation as consistent with stated intention, or they don’t. It doesn’t look like they are doing them, at least in a way that is consistent with a symmetrical 2% PCE inflation target referred to in the quarterly statements; and I wonder who is in need of a hefty dose fairness in that regard because there is no justification for the current state in any sense. As policy is naturally tightening, it is doing real damage for no rational reason which is hardly consistent with the mandates. And we simply have no idea how deep this rabbit hole will go.
I’ll be keeping tabs on employment so that I can measure approximately how many people this will be destroying in a somewhat tangible sense. I simply do not care if the central bankers have someone or something else to which to point the finger of blame. There are too many people who understand what is going on here for them to be able to conveniently pass the buck for their own negligence.
PS: An ounce of prevention is worth a pound of cure.