Looking back now, January was such a weird month. You had, on the one hand, the barely restrained giddiness of the mainstream media proclaiming ultimate success of 5% GDP and an Establishment Survey (and dutiful unemployment rate) that could do nothing wrong. To this view, the economy was a certainty.
Yet, on the other hand, markets around the world were growing very, very cautious and even a touch more than flighty. There was oil, dollars and “inflation” expectations that were just all wrong for the end of the non-recovery. These were, of course, to be papered over by nothing more than buzzwords; “strong dollar”, transitory, low oil is great for consumers, etc.
In the middle was the FOMC, gazing longingly and favorably on the heartwarming and even Hollywood ending that seemed to be there. Yet they were still mindful of the very dark turn in the markets. They said “strong dollar” but more than winced at what that might do. Policymakers shook off oil prices in public, but you could almost see their fingers crossed and a steady stream of “Hail Mary’s” or praying to whatever god of regression and rational expectations. They believed in the giddiness but yet they didn’t.
At her December 2014 press conference, in the prepared remarks, Janet Yellen laid out the path to confirmation:
Inflation has continued to run below the Committee’s 2 percent objective, and the recent sizable declines in oil prices will likely hold down overall inflation in the near term. But as the effects of these oil price declines and other transitory factors dissipate and as resource utilization continues to rise, the Committee expects inflation to move gradually back toward its objective. In making this forecast, the Committee is mindful of the recent declines in market-based measures of inflation compensation. At this point, the Committee views these movements as likely to prove transitory, and survey-based measures of longer-term inflation expectations have remained stable.
Again, I think they wanted to believe that was true but the nagging and gnawing reality of almost everything else prevented a full embrace. Publicly, they had to straddle between keeping that hope alive, under rational expectations, while privately muttering about how none of this “should” be taking place.
In the months since, the FOMC at various points as well as Yellen herself has been rather more open about those lingering and recessive concerns – especially wages. Wage growth, for all the fluff about economic strength, just never came. I highly doubt that will lead the Fed, as economists, to a wider awakening about what that really means (including that the Establishment Survey and GDP are simply overstating strength amidst unarguable, at least, instability) but it preserved through all the euphoria even to January of a much more than trivial downside.
In the minutes of the December FOMC meeting, released on January 7, there contained exactly this sentiment:
The risks to the forecast for real GDP growth and inflation were viewed as tilted a little to the downside, reflecting the staff’s assessment that neither monetary policy nor fiscal policy was well positioned to help the economy withstand adverse shocks.
That, as I wrote then, was likely the entire focus of this will they/won’t they drama. The FOMC is stuck, unable by their own inference of monetarism to proclaim success and withdraw fully but yet mindful that they couldn’t actually confirm it.
If the economy were to fall off in the near future, a possibility to which they are very worried that credit markets might be right about, there is little monetary policy can do to render “aid” in that situation. Of course, I don’t believe monetary policy is helpful in any sense, and it certainly wasn’t much of anything in 2007-09, but that is not what the orthodox textbook declares. If the FOMC is worried about the near-term turning against them, they believe it their sworn duty to interfere – but first they have to reposition everything so that they may do so. Thus QE must end, leading them to at least threaten the end of ZIRP. Preservation of the policy “surprise” is, I believe, the true aim here and has been before even Yellen succeeded Bernanke.
I have written consistently that I never thought they would ever get that far, to actually begin raising rates, but in the minds of “rational expectations” they had to at least plausibly threaten to. To create a recovery, in this twisted view of forced mathematical equalities, means they have to say it over and over and over no matter how imbalanced. That point has only been reinforced in the months since January, as those market-based concerns have proven far more correct than the extrapolations of 5% GDP and 5.5% “unemployment”; that is especially true since early July, as everything has taken another turn toward the dark.
It has led to this very strange almost duality, where the recovery in idea gets preserved even more as the recovery in fact dies away. For the June FOMC meeting, along with the huge downgrades in both economy and “inflation”, this tension was perhaps on full display:
I am more convinced than ever that the FOMC is simply trying to scare a recovery into existence. The June update to the Fed’s models for central economic tendencies were, in a word, atrocious. The economy was marked down in almost every facet, and not by a little. The upper boundary on the central tendency for GDP was dropped by 0.7%, all the way to just 2% from 2.7% at the March update. That means, given the current thinking which somehow includes an economy strong enough to consider ending ZIRP (from an orthodox perspective), this year is going to be worse than last year.
Somehow out of all that word salad statement, we are to assume that the Fed is even more convinced that the economy has only gotten better if only because it got worse?
The problem is rational expectations as a workable theory in practice outside of mathematics and models. The more concerned the FOMC gets about the actual downside the more they have to pretend, and stress, that there isn’t one.
Whenever I get to discussing “rational expectations theory” the typical response I get is one mostly of disbelief, as in whatever and wherever the theory is applied seems somehow to offend basic common sense and intuitive sensibilities. I don’t disagree at all, as I am not one to subscribe to the theory only observing how it fits within the paradigm of monetary economics – you don’t have to agree with it but you better understand it so you can better analyze why the Fed does what it does.
The reason “rational expectations” grates so much upon basic observations is that it is a symptom of orthodox economics’ dominating tendency to make reality fit its models. In other words, “rational expectations” is nothing more than a mathematical variable in a set of equations designed to generate a “generalized equilibrium.” Yet another way of thinking about it is that the math is so narrowly defined and construed “rational expectations” is the means solely by which the equations are solvable without disqualifying infinities.
Since the math works under these assumptions, economists have set out to define their view of the real world to match the math, which is why it often sounds, essentially, ludicrous.
The Wall Street Journal, as it so often does, bridges today these positions under orthodox assumptions that the economy is still awesome and that FOMC thinking is about some distant problem that is but a trivial concern. Yet, in plain view of this changing behavior for their own part, it simply cannot be either distant or trivial, can it?
As the U.S. economic expansion ages and clouds gather overseas, policy makers worry about recession. Their concern isn’t that a downturn is imminent but whether they will have firepower to fight back when one does arrive.
The Journal alludes to Japan and China, still Europe despite the ECB constantly doing all the same things as the Fed, but there is more than a little hint of disingenuousness coiled within the text of the article. The entire point is if the US falls into recession while still encompassed by “emergency” monetary “aid.” That would at least suggest, especially with eight years of it already, something far more than a little wrong with the world but also of monetarism itself. They can blame outside and exogenous forces and “shocks” all they want, but in this gaining philosophical exercise of doubt and worry, the central point is that the FOMC delivered, in its mind, beyond its full weight in monetary intervention and still it fell far, far short of conveyance.
This is more than a mere ratchet effect. The Fed gave it all it got and the economy never got back up. Now there are the real and growing prospects of the economy getting hit yet again having never been remotely healed from the last time. For a policymaker that even still believes in monetarism, that has to be terrifying all at once no matter how much in public you declare it to be impossible (especially since, even in the public narrative, impossible has become far less so in the space of just a few months). This is, hopefully, the final decay and descent past fecklessness into the realm of openly realized powerlessness. The list of central banks falling prey to the unwinding eurodollar standard is only growing in 2015, at some point you have to think the Fed will be added.
While the overall tone of the Journal article is meant to reassure and offer comfort that effective commandment and central planning can still be preserved under these “hypothetical” circumstances, the mere fact of its writing instead of more untarnished admiration and commendations about monetary success in the past tense exposes this complete downgrade in the recovery narrative in 2015. Thinking about the next cycle before finishing the last is an enormous transformation, and really, again, a terrifying prospect.
“The world economy is like an ocean liner without lifeboats,” economists at HSBC Bankwrote in a recent research note.
In the next downturn, former Fed Chairman Ben Bernanke said in an interview, the tools of government will be “more limited than usual, but they’re not zero by any means.”
“This is a very live question,” said Douglas Elmendorf, the recently departed director of the Congressional Budget Office. “Policy makers are thinking about their backup, backup plans.”
The Fed’s strategy of keeping interest rates low well into an expansion is intended to help avoid a relapse into recession. Fed Chairwoman Janet Yellen has described low rates as insurance against another downturn. That is another reason officials intend to move slowly once they begin nudging up rates.
“Intend to move slowly” gets slower with each “dollar” wave and that is the relevant motion of policy and economy quite against all the continued propaganda.