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On Rate Hikes, Powell Makes Like Sergeant Schultz, Instead Recaps His Case on Inflation

In his speech today, Powell did not address the one question everyone expected him to address. Instead, he stuck with his "Inflation is Transitory" thesis.
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Powell Offers No Clues on Tapering or Rate Hikes

Powell's Virtual Jackson Hole Speech

The Fed normally meets in Jackson Hole, Wyoming every year to go over policy. This year, the meeting was virtual. 

Powell delivered the keynote address before the Federal Reserve Bank of Kansas City's Economic Policy Symposium. 

Monetary Policy in the Time of Covid

Here's a full transcript of Powell's speech, Monetary Policy in the Time of Covid with key points below.

Uneven Recovery in Goods vs Services

Figure 1 Powell

The unevenness of the recovery can further be seen through the lens of the sectoral shift of spending into goods—particularly durable goods such as appliances, furniture, and cars—and away from services, particularly in-person services in areas such as travel and leisure (figure 1). As the pandemic struck, restaurant meals fell 45 percent, air travel 95 percent, and dentist visits 65 percent. Even today, with overall gross domestic product and consumption spending more than fully recovered, services spending remains about 7 percent below trend. Total employment is now 6 million below its February 2020 level, and 5 million of that shortfall is in the still-depressed service sector.

Maximum Employment

Figure 2 Powell

The outlook for the labor market has brightened considerably in recent months. After faltering last winter, job gains have risen steadily over the course of this year and now average 832,000 over the past three months, of which almost 800,000 have been in services (figure 2). The pace of total hiring is faster than at any time in the recorded data before the pandemic. The levels of job openings and quits are at record highs, and employers report that they cannot fill jobs fast enough to meet returning demand.

These favorable conditions for job seekers should help the economy cover the considerable remaining ground to reach maximum employment. The unemployment rate has declined to 5.4 percent, a post-pandemic low, but is still much too high, and the reported rate understates the amount of labor market slack

The Path Ahead: Inflation

Figure 6 Powell
  1. Absence so far of broad-based inflation pressuresThe 12-month window we use in computing inflation now captures the rebound in prices but not the initial decline, temporarily elevating reported inflation. These effects, which are adding a few tenths to measured inflation, should wash out over time.
  2. Moderating Inflation: We are also directly monitoring the prices of particular goods and services most affected by the pandemic and the reopening, and are beginning to see a moderation in some cases as shortages ease. 
  3. Wages: If wage increases were to move materially and persistently above the levels of productivity gains and inflation, businesses would likely pass those increases on to customers, a process that could become the sort of "wage–price spiral" seen at times in the past. Today we see little evidence of wage increases that might threaten excessive inflation. The Atlanta Wage Growth Tracker, show wages moving up at a pace that appears consistent with our longer-term inflation objective. We will continue to monitor this carefully.
  4.  Longer-term inflation expectations: We carefully monitor a wide range of indicators of longer-term inflation expectations. These measures today are at levels broadly consistent with our 2 percent objective. Longer-term inflation expectations have moved much less than actual inflation or near-term expectations, suggesting that households, businesses, and market participants also believe that current high inflation readings are likely to prove transitory and that, in any case, the Fed will keep inflation close to our 2 percent objective over time.  The Board staff's index of common inflation expectations (CIE), which combines information from a broad range of survey and market-based measures shows a welcome reversal of that decline starting around 2014 and is now at levels more consistent with our 2 percent objective.
  5. The prevalence of global disinflationary forces over the past quarter century: Finally, it is worth noting that, since the 1990s, inflation in many advanced economies has run somewhat below 2 percent even in good times. The pattern of low inflation likely reflects sustained disinflationary forces, including technology, globalization and perhaps demographic factors, as well as a stronger and more successful commitment by central banks to maintain price stability.13 In the United States, unemployment ran below 4 percent for about two years before the pandemic, while inflation ran at or below 2 percent. Wages did move up across the income spectrum—a welcome development—but not by enough to lift price inflation consistently to 2 percent. While the underlying global disinflationary factors are likely to evolve over time, there is little reason to think that they have suddenly reversed or abated. It seems more likely that they will continue to weigh on inflation as the pandemic passes into history.

Implications for Monetary Policy (Emphasis Mine)

The early days of stabilization policy in the 1950s taught monetary policymakers not to attempt to offset what are likely to be temporary fluctuations in inflation. Indeed, responding may do more harm than good, particularly in an era where policy rates are much closer to the effective lower bound even in good times

The main influence of monetary policy on inflation can come after a lag of a year or more. If a central bank tightens policy in response to factors that turn out to be temporary, the main policy effects are likely to arrive after the need has passed.

History also teaches, however, that central banks cannot take for granted that inflation due to transitory factors will fade. The 1970s saw two periods in which there were large increases in energy and food prices, raising headline inflation for a time. But when the direct effects on headline inflation eased, core inflation continued to run persistently higher than before. One likely contributing factor was that the public had come to generally expect higher inflation—one reason why we now monitor inflation expectations so carefully.

Central banks have always faced the problem of distinguishing transitory inflation spikes from more troublesome developments, and it is sometimes difficult to do so with confidence in real time. 

We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the "substantial further progress" test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.

The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time.

Rate Hike and Tapering Synopsis

National Nothing Day

Please celebrate National Nothing Day along with Sargeant Jerome Powell. 

Powell did not address the key issues on everyone's mind. When and how much will tapering and rate hikes occur. 

Powell also made no mention of asset bubbles or reverse repos.

Powell's Three-Point Message

  1. Inflation is Transitory.
  2. Inflation is Transitory.
  3. Inflation is Transitory.

Consumer Inflation Expectations Hit a New 8-Year High

I saw comments today that Powell's speech was a Nothingburger. 

I disagree, while simultaneously disagreeing some of Powell's key ideas.   

The notion that inflation expectations have any relevance is totally potty. Curiously, the Fed's measures did not seem to incorporate (or ignored) the New York Fed's actual assessment of consumer inflation expectations. 

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 On August 12, I commented Consumer Inflation Expectations Hit a New 8-Year High

I also commented "Contrary to widespread belief that inflation expectations matter, they are actually meaningless and the above charts show just that." See link for details.

Effective Lower Bound

Buried in Powell's speech was an obscure reference to Effective Lower Bound.

ELB is the point at which further monetary stimulus is counterproductive. That's the case in the ECB where interest rates are negative. 

Banks lose money on deposits and the only demand for money is from borrowers who are bad risks. 

I discussed this on September 25, 2019 in In Search of the Effective Lower Bound

If we are not already at the ELB in the US, we are certainly close. 

There is a Negative Demand for Deposits to the Tune of 1.1 Trillion Dollars

One factor supporting the notion we are at or close to ELB is the Fed's insistence on not letting short-term rates drop below zero. 

I have discussed this many time but most recently in There is a Negative Demand for Deposits to the Tune of 1.1 Trillion Dollars.

The Fed is still doing QE to the tune of $120 billion a month. The Fed simultaneously does $1.1 trillion in reverse repos which are essentially reverse QE or tapering. 

This is of course mathematically crazy, but Powell is sticking with it.

What About Asset Bubbles?

The Fed made no mention of either bubbles or the mad setup in reverse repos.  

The Fed has never made the case for 2% inflation. 

All we know is the Fed wants more inflation and that it wants to make up for inflation it believes was too low in the past.

That is despite the fact that wages are not even keeping up with reported inflation let alone housing prices.

Why It's Transitory 

In two words, I can easily make the case that inflation is transitory.

Bubbles Burst.

A sustained downturn in the stock market will wreak havoc with consumer spending and demand for all kinds of goods and services. 

We have seen this twice already, in the DotCom bubble and in the Great Financial Crisis. 

In both cases the Fed itself sowed the seeds of a financial crisis. 

The Fed willingly does so again, and on the flimsy case for needing more inflation even though it is clueless about how to measure it.

Bubbles are all the Fed has, so it has to ignore them. That is the real takeaway from Powell's speech today.

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