The Fed and the Punchbowl

The table below shows the changes in unemployment rates during six expansionary time periods in the US – generally growth periods following recessions between 1975 and 2021.  

I present this information to help us think about the prospects of a rise in inflation in coming months and years. I do this mostly because the Federal Reserve seems to think that inflation is not a worry now. Their main task, it seems, is to keep the economy humming through near-zero interest rates. Many Fed officials are on record as to the fact that even if we observe some recent changes in the inflation rate, they are probably temporary.

My table refers to the idea that a rapidly growing economy that generates reductions in the unemployment rate often results in higher inflation. Once the Fed observes a significant and durable rise in inflation, then they are compelled to remove the punchbowl from the party.

It is important, therefore, to wonder what the unemployment rate is saying about prospects of durable inflation. To that effect I created the below table which shows unemployment rates in six expansionary periods from 1975 to 2021.

In each of those expansionary periods the unemployment rate declined. The declines varied. For example, in 2003, the unemployment rate peaked at 6.3% and subsequently fell to 4.4%. The change in the unemployment rate was 1.9 points. In 1982, the unemployment rate had peaked at 10.8% and then fell to 5.2%. The change in the unemployment rate was -5.6 points. The common factor in all these episodes of economic expansion was a significant, though variable, reduction in the unemployment rate. In all but one of those episodes inflation increased.

Next, consider the last row of the table. It shows that the unemployment rate had risen to almost 15% in 2020. By early 2021 it had fallen by 8.8 points to 6%.

Some remarks. In the 2020 case, unemployment peaked at a very high rate – higher than any of the previous time periods. But it is also true that the unemployment rate quickly fell by 8.8 points – the largest reduction in the table. While the 6.0% rate in 2021 is not the lowest in the table it is considerably lower than the high rates in the table. That lower rate is already capable of generating inflation.

Summarizing. If the Fed thinks current increases in inflation are temporary, or if they think the unemployment rate has not yet gone low enough to start inflation – then they are not looking at the numbers.

They need to quit mumbling around and waiting for a clear sign from above. It is past time to think about anchoring inflation and expectations of future inflation. It is time to take the punchbowl away from the party. 

 

Table. Unemployment Rate During US Expansions

1975  8.8    1979  5.7   Dif -3.1 

Note: Inflation rose

  

1982 10.8    1990 5.2   Dif -5.6

Note: Inflation rose

 

1992 7.8     2000  3.8  Dif -4.0 

Note:  Inflation did not rise

 

2003 6.3     2007  4.4  Dif -1.9

Note: Inflation rose

 

2009 9.9     2020  3.5   Dif -6.4

Note: Inflation rose

 

2020  14.8   2021  6.0   Dif -8.8

Inflation?

  

A Little Ditty about April Inflation

If you have paid attention lately, April’s CPI number came out and everyone is atwitter. Apparently, inflation is back and is wounding the stock market and like a Bono reunion, it is causing quite a stir.

Us older folks remember the 1970s when inflation kept rising and eventual turned into something called stagflation. We surely don’t want that to happen again. And it snuck up on us after almost no inflation during most of the 1960s, it seemed to surge out of nowhere via excessive money emission and government deficits. Food and energy crises definitely helped.

Given all the crazy things happening lately it is no wonder inflation is catching our attention and concern. But let’s be honest – the news media sector doesn’t much care if they are correct as they benefit from colorful story-telling.

I decided to get away from all the theorizing this week and focus more on the common sense of numbers. The main point here is that what goes up often comes down. That has something to do with gravity. But what about when something goes down? Does it have to come back up? There is no rule of gravity to help us there.

If something typically grows by 3% per year and then it grows by only 2% this year – we expect it to mean reverberate. We expect it to go back to 3%. That means it might hit 4% this year as the 2% and the 4% average to 3%. No, it isn’t always that simple – but if a phenomenon really does average 3% then it is reasonable to think it will go back to that after it has temporarily diverged.

The consumer price index is a commonly used measure of the prices of things the average consumer buys. It is published each month. In April of this year it sprung to a value of 266.8. In April of 2020, it had been 256.2 so the one-year increase was about 4.1%. That’s a big number for inflation these days. Markets went crazy.

But one thing the market seems to be missing is that The CPI went from 255.3 to 256.2 between April of 2019 to April of 2020. That was a small increase. In percentage terms it was 0.35%. That’s hardly different from zero! That shows you that 2020 was a really unusually crazy year. Zero inflation! Many commentators admit that most of the things happening that year (Covid, a recession, and Tuna’s colonoscopy) may have caused temporary changes in inflation. Clearly a Zero percent inflation is unusual and not expected to last.

So what might you expect in the next year? In 2021? Perhaps a movement back to normalcy? And that’s what happened.

The CPI in April 2017 was 244.3 rising to 255.3 in April 2019 – for a two-year inflation rate of about 4.5%. The two-year inflation rate from April of 2019 of 255.3 to this April of 266.8 was again 4.5%.

Hmmm. The two year inflation rate from 2019 to 2021 was exactly the same as the average of the previous two years – 2017 to 2019. And people were not jumping off buildings because of inflation.

Yes, we had a serious rise in inflation in the past year. Does that mean trouble? Maybe. But it might also mean we are headed back to some sort of normalcy. But, of course, normalcy doesn’t sell airtime.

Last point. Once the temporary factors recede, we are left with a chance to bring our monetary and fiscal situation back to something less crazy. If we don’t, I am afraid that stronger growth coupled with excessive policy stimulation will be enough to bring us back to Jaws, One Flew Over the Cuckoos’ Nest, and the 1970s. Still got those cool bell bottoms? 

A Fictional Dialogue with Robert Kaplan of the Dallas Fed

Note: I wrote this post at least a week ago. More recently Janet Yellen -- a former Federal Reserve boss --  started to back away from low interest rates -- but then changed her mind. So as I write today, the Fed and the Treasury seem united in thinking inflation is not a threat and preferring to stick with near-zero interest rates. 

Below I pulled some key words from a WSJ article* about Robert Kaplan's Policy views. My comments below are in italics after .............. 

Federal Reserve Bank of Dallas President Robert Kaplan said it isn’t time for the central bank to pull back on its support of the economy, but paring stimulus when it becomes clear the coronavirus pandemic is abating and the economy is meeting the Fed’s goals will be important to keep the recovery on track..........when will it become clear? Might they wait too late?

When we’re in the middle of a crisis, we should be aggressively using our tools, so I agree with what we’re doing now in terms of asset purchases and stance of policy generally, .............are we really in the middle of a crisis?

Mr. Kaplan declined to give a timeline for when those conditions might be met. The official remains upbeat about the economy and forecast 6.5% growth this year, with the jobless rate dropping to 4% this year....the jobless rate is dropping to 4% and he says we are in a crisis? When will he know when the economy is strong enough so they can begin to pull back all that stimulus?

There’s reason to be optimistic about the future,” the official said, adding, Having said that, I would also emphasize it is my view that we’re not out of the woods yet............I repeat, when will he know we are out of the woods? When will he want to take his foot off the accelerator?

Determining when the pandemic has largely passed is a conversation that will take place in conjunction with health policy experts. But once clarity on that question emerges, the Fed should trim its support to keep it commensurate with what the economy needs........Is Dr Fauci going to run the Fed? When will Covid's future be clear?

I reserve the right to change my mind, and update my views depending on how the economy performs, Mr. Kaplan said Tuesday........wow -- now that's a commitment to a clear policy we can bank on. 

Market excesses and imbalances can seem benign while it’s going on, but if it goes too far, if you have somewhat of a shock or an adjustment or you’re getting back to normal and people need to some extent de-risk, it can create a severe tightening in financial conditions which can slow the economy,” Mr. Kaplan said.......okay now he is honest but that honesty does not go with his policy view. Yes, it will hurt if you hit yourself in the head with a hammer -- but go ahead and keep hammering. You will know when to stop hitting yourself in the head.

That is why at some point it will be important for the Fed to trim back support, the official said.....how do we know when we are at that point? How will he know? Seems to me we are there already. 

All things being equal, I am going to be much more willing to be accommodative or highly accommodative in the months and years ahead in order to achieve our goals,” Mr. Kaplan said, ....aha. Months and years. Years? Really? Sounds to me like he is never going to judge the economy to be healthy. And as he said -- then the fit will hit the shan. 

*https://www.wsj.com/articles/feds-kaplan-says-the-economy-still-needs-central-bank-support-11617787800?mod=hp_lista_pos2

President Biden and Cause & Effect

I watched President Biden's speech and I came away thinking about cause and effect. Before I get more into that idea, let me say that he really knows how to deliver a speech. I have heard of bully pulpits before, but he really mastered the art. He was incredibly strong and persuasive. 

Having said that, I want to make a distinction between cause and effect. When your big toe hurts, you do not bring in your nearest evangelist and have him or her give your toe a talking to. You don't hire the Dallas cheerleaders to cheer on your big toe.  Most of us go to a doctor who knows something about toes. He or she uses her training and experience to decide what can be done to fix your toe. When she tells you to apply a remedy, you might be persuaded and you are on to feeling better. While it might be nicer and more fun to have the Dallas Cheerleaders cheer on your toe -- you'd rather deal with a doctor.

This point can be exaggerated. Sometimes the problem is really emotionally based and a good cheering on can be the remedy. And sometimes a doctor might get it all wrong. So let's be clear -- cause and effect allows for both science and emotion. 

But more frequently, we stick to cause and effect in the sense of science.  If we want a rocket to head toward the moon, we might pray for a safe journey but before that we need to build a good rocket using science. If we want our lawn to look nicer we don't cheer on the grass, we put gas in our mower. 

I know I am aggravating some of you.

But to me this is all relevant when I think about Joe Biden's speech the other night. While he is an expert at enumerating and describing many of our modern ills, and while he is passionate and persuasive about us wanting and needing solutions -- I never heard him say a peep about what causes these things. Apparently what causes all our ills is that the government is too small and rich people get to have all the fun. 

Take poverty or inequality of income as an example. Why are people poor? Why are incomes unequal? Did he ever say why? He ranted about rich people. But are you sure that rich people exist to make other people poor? Is there no other explanation for why people are poor? Do those other reasons not deserve a minute or two in his speech? 

And he is so sure that if the government spends more money, then poverty will be greatly improved? Trust in the government. But really? How long have we had poverty programs? If they are so good, then why do we continue to have poverty? Because Trump put in a reduction in tax rates? Do you really believe that's the beginning and the end of the story?

Is poverty really so simple that we can wave a magic wand and it will disappear? Is the government so powerful and smart that it will use all that money they get from the rich to make large and lasting reductions in poverty? Do we have sophisticated models of the causes of poverty and do the programs being put forward really have substantial and durable effects?

I think all these questions can be answered. But Joe Biden is more interested in whipping up emotion than in being serious about how we solve our nation's problems. He has been in government a long time and yet he points the finger of blame at the other party. Maybe he and his advisors should spend less time whipping up emotions and more time in the library figuring out what is really wrong and what can usefully be done about it.