Tuesday , December 18 2018
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What kind of Fed “put”?

Summary:
This caught my eye: The Federal Reserve has to be careful for appearing to flinch from hiking interest rates due to market volatility or investors will soon be banking on a “Powell put,” said Mohamed El-Erian, chief economist at Allianz. The Fed’s most recent message, delivered by Fed Vice Chairman Richard Clarida, stressed the Fed is data dependent. This seems to be a shift from the earlier communication that there was a clear need to normalize policy, said El-Erian, the former deputy director of the International Monetary Fund and later the CEO of PIMCO. This shift seems to be a reaction to market volatility in October rather than any “great discovery” about the economic outlook, he said. . . . “In the last week or so, the word data dependency has started coming back. So

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This caught my eye:

The Federal Reserve has to be careful for appearing to flinch from hiking interest rates due to market volatility or investors will soon be banking on a “Powell put,” said Mohamed El-Erian, chief economist at Allianz.

The Fed’s most recent message, delivered by Fed Vice Chairman Richard Clarida, stressed the Fed is data dependent. This seems to be a shift from the earlier communication that there was a clear need to normalize policy, said El-Erian, the former deputy director of the International Monetary Fund and later the CEO of PIMCO. This shift seems to be a reaction to market volatility in October rather than any “great discovery” about the economic outlook, he said.. .

“In the last week or so, the word data dependency has started coming back. So this is going to be a real test as to whether the Powell Fed is indeed a different Fed or whether at the first sign of market volatility they flinch like the Bernanke Fed and the Yellen Fed.”

Mohamed El-Erian 

“If they signal that they are going to be more dovish, I can tell you we will be talking about the ‘Powell put’ really soon, so they have to be really careful,” he added during an interview on CNBC.

Should there be a Fed put based on stock prices?  No.

Should there be a Fed put based on asset prices?  Yes.

It’s a mistake to put too much weight on stock prices.  While stocks do react to changes in expected growth in aggregate demand, they also react to lots of other stuff, such as corporate profits, growth in overseas economies, deregulation, tax cuts, trade wars, interest rates, etc.  Instead the Fed should put together a market forecast of expected NGDP growth.  Preferably they’d create and subsidize trading in a NGDP futures market, but at a minimum they should try to estimate the market’s forecast of NGDP growth, based on a wide range of indicators, including stock prices.

There’s nothing wrong with the Fed easing policy after a sharp setback in the stock market, but only if it’s associated with a decline in expected NGDP growth.  I’m not seeing evidence for that in the Hypermind prediction market, but that contract runs out in the first quarter of 2019, so one could argue that the slowdown is expected to occur later.  On the other hand, forecasts of slower growth in the future usually lead to slower growth in the near term as well.

FWIW,  I believe that the Fed should and will raise interest rates by less than they currently anticipate–perhaps just one or two more increases.  But my view is “data dependent”, and might change by tomorrow.

Off topic: The GOP now believes that corporate decisions about where to locate new factories should be made by the federal government, not the private sector.

Update:  The Dems appears to have picked up 40 House seats, with California’s 21st flipping to the Dems yesterday after the GOP led by 7 points on election night.  Congrats to David Levey for predicting precisely this result.  I’d like to see a story explaining why the late votes in California are so overwhelmingly Democratic.  On election night, the media missed the Democratic wave, with pundits talking about Dem House gains of about 28 and GOP Senate gains of perhaps 3 or 4.  It’s now 40 and 1, or 2 at most.  We need better election technology.  There’s no excuse for the slow pace of vote counting.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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