Another round of forecasts, and another month where the Fed screams “on hold until further notice” — and the street fails to listen.
The forecasts are too weak for rate hikes – unless the Fed’s reaction function has changed. But the Street doesn’t spell out why the Fed’s reaction function might have changed – some try and the too low for too long story, but that can’t work, as Bernanke himself told us it he doesn’t think the bust was the Fed’s fault.
Anyhow, the skinny is that the Fed’s Nov 2010 forecasts suggest they are on hold at zero until 2014/15. Using the SF Rudebusch Taylor Rule, these forecasts imply that the optimal rate will rise above zero in Q1’13.
However, it remains below 1% until 2014. This is important, as we know from Bernanke’s Princeton speech that he’s approves of Reifschneider & Williams (2000) – so we know the Fed won’t hike until the optimal rate is above 1%.
This means the first hike is probably not until H2’12014/ H1’15.
One escape hatche some analysts climb through is the claim that the NAIRU is much higher, and a Fed tightening in 2011/12 is consistent with the data … the problem with this is that we know what the Fed thinks the NAIRU is – they tell us!
Sure, it’s increased during the crisis – the mid of the range is now ~5.5%, up from 5.15%, and sub 5% pre-GFC- but it’s got a long way to go before it reaches 7%.
The Fed slightly lowered their growth numbers, increased their unemployment rate forecast, and increased their inflation forecast.
From the perspective of policy, these were actually slightly hawkish revisions. The higher NAIRU does more work than the slightly higher unemployment rate – helped by minor upward revisions to the core PCE forecast – and results in a slightly higher optimal path for the Fed funds rate.
Inflation remains too low and unemployment too high – so policy will remain super-easy – but it’s not as bad as it was before QE2.
So QE2 did work? A small bit? Sumner reckons not enough:
“The Fed’s own internal forecasters just issued a new set of macro forecasts, which are essentially telling Bernanke that $600 billion isn’t enough. More is needed.”
Good luck to Bernanke trying to convince FOMC to go easier.
btw – if NAIRU estimates are going up, that’s really a second order effect.
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