As of 2023-01-20: My guesses as to the form and shape of the inflation process currently going on in the United States, and my guesses as to the proper stance of monetary policy right now. A draft...
The Fed may need to call it a day and soon. The annualized rate of headline CPI inflation in Q4 of 2022 was about 3.1% and that of Core CPI inflation was about 4.4%. And as Christie Romer points out, we may not have started to see the lagged effects of the monetary tightening yet.
I see that for December, average weekly earnings are down from the previous month. Retail sales excluding gas and autos are down from the previous month. Freddie Mac's national house price index is down for its 5th straight month. Apartment Lists national rental price index has fallen for its 4th consecutive month. Core CPI is up 3.7% annualized from the previous month, but is negative if the highly imputed and lagged Shelter component is excluded.
And we're really considering raising interest rates because core services less housing inflation is too high? Q4 PCE data isn't out for a week, but Q4's CPI services less shelter is 0.9% annualized.
What am I missing? Is everyone else looking at Year over Year data?
Also, if I may in another comment, you are right to set aside the theories for the time being and listen to Mr. Bond Market under these unusual economic circumstances. It thinks that the Fed is making a mistake and may have to retrace at least one or two steps. This isn't Mr. Bond's most recent itch. It has been quite resolute about this for a while.
I feel about macroeconomic theory the same way that George Washington felt about religion. It is very important for people to believe that the FOMC is possessed of some form of higher truth, even if they are really just a bunch of reasonably smart folk who are otherwise as much in the dark as the rest of us. Otherwise, the FOMC would not be able to function in our democratic polity. Americans don't defer much to authority, but they still bow to miracle and mystery. The same is true of the courts, but academic lawyers are more willing than economists to admit that there is no there there.
El Erian: Does he mean that the Fed’s model was wrong. The model said raise FF rates in March 2022 when It should have said September 2021 (or some other date?) And, supposing he is wrong, is he is wrong because of HIS theory? (Ditto Hubbard, Kashkari.) And even if we think they are right that the Fed should have started tightening sooner, how does that translated into it needing to tighten more now?
“Such discussions seem to me to mean…”
They are supposed to mean that the Fed sees it obligation to _flexibly_ stabilize average inflation at 2%, where both the 2% and the degree of flexibility at any time are chosen to facilitate market clearing given shocks and heterogeneous price flexibility.
“neutral rate of inflation”—the rate of inflation below which you should not try to push the economy”
Surely the target is at least that! Although it would mean not push the economy above that rate, either, except “flexibly” in response to extraordinary shocks.
“But how high is the natural rate of inflation in normal times? And how does it alter in times of supply shocks and of sectoral-rebalancing demand shocks? Not enough economists have spent not enough time on these issues.”
Answering these questions correctly is the TOR of the Fed. And grading the exam is the TOR of macroeconomists.
The remainder of your piece is I guess – above my pay grade – such a grading process in real time before all the questions have been answered. Both pass and fail are still possibilities but you fear a borderline D.
I think that we (others not I) _do_ have a theory, but it’ like string theory that it has so many degrees of freedom that you can’t derive monetary policy instrument settings from it. Still, I think it would help if the Fed and its commentators talked about finding the instantaneous rate of inflation that kept resources as fully employed as possible given the need for relative prices to change and heterogeneity in the flexibility of prices.
Is our tight labor market now due to excess demand (in which case, shouldn't inflation be broad based?), or is it insufficient supply of labor? Because if low immigration, retiring boomers, and millennials on the steep part of the raise curve are the "problem", then maybe that should be solved by Congress and employers rather than beating aggregate demand to a bloody pulp.
DRAFT: Þe First Inflation Problem of þe 21st Century
The Fed may need to call it a day and soon. The annualized rate of headline CPI inflation in Q4 of 2022 was about 3.1% and that of Core CPI inflation was about 4.4%. And as Christie Romer points out, we may not have started to see the lagged effects of the monetary tightening yet.
I see that for December, average weekly earnings are down from the previous month. Retail sales excluding gas and autos are down from the previous month. Freddie Mac's national house price index is down for its 5th straight month. Apartment Lists national rental price index has fallen for its 4th consecutive month. Core CPI is up 3.7% annualized from the previous month, but is negative if the highly imputed and lagged Shelter component is excluded.
And we're really considering raising interest rates because core services less housing inflation is too high? Q4 PCE data isn't out for a week, but Q4's CPI services less shelter is 0.9% annualized.
What am I missing? Is everyone else looking at Year over Year data?
Also, if I may in another comment, you are right to set aside the theories for the time being and listen to Mr. Bond Market under these unusual economic circumstances. It thinks that the Fed is making a mistake and may have to retrace at least one or two steps. This isn't Mr. Bond's most recent itch. It has been quite resolute about this for a while.
I feel about macroeconomic theory the same way that George Washington felt about religion. It is very important for people to believe that the FOMC is possessed of some form of higher truth, even if they are really just a bunch of reasonably smart folk who are otherwise as much in the dark as the rest of us. Otherwise, the FOMC would not be able to function in our democratic polity. Americans don't defer much to authority, but they still bow to miracle and mystery. The same is true of the courts, but academic lawyers are more willing than economists to admit that there is no there there.
El Erian: Does he mean that the Fed’s model was wrong. The model said raise FF rates in March 2022 when It should have said September 2021 (or some other date?) And, supposing he is wrong, is he is wrong because of HIS theory? (Ditto Hubbard, Kashkari.) And even if we think they are right that the Fed should have started tightening sooner, how does that translated into it needing to tighten more now?
“Such discussions seem to me to mean…”
They are supposed to mean that the Fed sees it obligation to _flexibly_ stabilize average inflation at 2%, where both the 2% and the degree of flexibility at any time are chosen to facilitate market clearing given shocks and heterogeneous price flexibility.
“neutral rate of inflation”—the rate of inflation below which you should not try to push the economy”
Surely the target is at least that! Although it would mean not push the economy above that rate, either, except “flexibly” in response to extraordinary shocks.
“But how high is the natural rate of inflation in normal times? And how does it alter in times of supply shocks and of sectoral-rebalancing demand shocks? Not enough economists have spent not enough time on these issues.”
Answering these questions correctly is the TOR of the Fed. And grading the exam is the TOR of macroeconomists.
The remainder of your piece is I guess – above my pay grade – such a grading process in real time before all the questions have been answered. Both pass and fail are still possibilities but you fear a borderline D.
2% PCE = 2.4 CPI? Bingo. liner regression 2015-present 2.39%; 2001 to present 2.33%
I think that we (others not I) _do_ have a theory, but it’ like string theory that it has so many degrees of freedom that you can’t derive monetary policy instrument settings from it. Still, I think it would help if the Fed and its commentators talked about finding the instantaneous rate of inflation that kept resources as fully employed as possible given the need for relative prices to change and heterogeneity in the flexibility of prices.
Is our tight labor market now due to excess demand (in which case, shouldn't inflation be broad based?), or is it insufficient supply of labor? Because if low immigration, retiring boomers, and millennials on the steep part of the raise curve are the "problem", then maybe that should be solved by Congress and employers rather than beating aggregate demand to a bloody pulp.