Please consider Is the Fed behind the Curve? Two Interpretations, by James Bullard.
Key Bullard Ideas
- U.S. inflation is exceptionally high, comparable to that in 1974 and 1983.
- Standard Taylor-type monetary policy rules, even if based on a minimum interpretation of the persistent component of inflation, still recommend substantial increases in the policy rate. This provides one definition of “behind the curve,” and the Fed is far behind.
- However, all is not lost. Modern central banks are more credible than their 1970s counterparts and use forward guidance.
- Credible forward guidance means market interest rates have increased substantially in advance of tangible Fed action. This provides another definition of “behind the curve,” and the Fed is not as far behind based on this definition.
Inflation Well Above Target
A Generous Interpretation
- In my definitions of “behind the curve,” I will use the most generous (lowest) interpretation of the persistent component of current inflation, which is the 3.6% Dallas Fed trimmed mean value.
- This will help give us a “minimal” definition of the degree to which the Fed is behind the curve in the calculations in the following slides.
- We should keep in mind that this minimal definition excludes some inflation that is actually occurring, and that the Fed’s inflation target is ultimately stated in terms of headline inflation.
Credibility and Forward Guidance
- Modern central banks have considerably more credibility than they did in the 1970s, much of it stemming from an explicit commitment to inflation targeting.
- They also make more use of forward guidance.
- As a result, indications of future policy rate increases are incorporated into current financial market pricing, before policy actions are taken.
- This has been a key factor in current market pricing, as the 2-year Treasury yield and the 30-year mortgage rate have increased substantially.
Where to Start?
There is so much ridiculous nonsense by Bullard, it’s difficult to pick a starting point.
Bullard produces charts of the jobs market as evidence of a “strong economy.” The economy always looks strong at the peak of the cycle. The economy looked strong in 2007 and 2001 too.
Bernanke denied a housing bubble and Greenspan was fearful the dotcom miracle would cause overheating.
Forward Guidance
Is forward guidance a strength? I think not. It allows market forces to front run the Fed in both directions. And the guidance assumes the Fed is right.
Housing
Home prices are not in the CPI, the PCE, or the most absurd construct of all, trimmed-mean PCE.
Core PCE excludes food and energy.
Put housing in the CPI and inflation is running about 10 percent year-over year.
Percent Change From Year Ago Notes (January 2022)
- CPI: 7.48%
- OER: 4.09%
- Rent: 3.76%
- Case-Shiller 10-City: 17.52%
- Case-Shiller National: 19.17%
CPI Understated?
Yes, by a lot.
I do not believe OER is only up 4.09%. Nor do I believe rent is only up 3.76%.
Moreover, home prices are not directly in the CPI, only OER and and Rent.
For discussion please consider 2021 Set New Annual Records for Home Prices. 2022 Continues the Trend.
Trimmed Mean Inflation
Please consider my January 4, 2022 post Trimmed Mean Inflation Is the Ultimate Absurdity in Inflation Measures
- The Dallas Fed chopped off items with a combined weight of 24.07% from the low end.
- This was “balanced” by chopping off items with a weight of 32.50% (100-67.5) at the top end.
- Everything that went up by more than 9% annualized was chopped off the top culminating with gasoline up 103.5% and air transportation up 112.7%.
Ultimately, the Dallas Fed discarded 56.57% of the entire PCE, heavily weighted by discarding high inflation items to arrive at a preposterous 2.8% year-over-year measure of inflation.
If you throw away 57% of consumer items and not factor in housing at all, the current measure of trimmed mean is 3.6%.
And by that measure the Fed is not behind the curve.
What a Hoot!
This post originated at MishTalk.Com.
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