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The premises don’t follow from the conclusion

Summary:
Consider the following claims: 1. The Fed has tightened policy over the past few years. 2. The likely Fed rate cut in July shows that they made a mistake in raising rates last year. 3. The fact that unemployment has fallen to lower levels than anticipated provides further evidence that the Fed erred in raising rates. 4. The Fed should do a full 50 basis point cut in July, not a measly 25 basis point cut. I believe the fourth claim (the “conclusion”) is true, but I don’t get to this place via the same path as many “doves”. I do not accept the first three claims (the “premises”). 1. Monetary policy has actually eased since Trump was elected, as evidenced by a significant speed-up in NGDP growth. 2. A rate cut in July does not show that the previous

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Consider the following claims:

1. The Fed has tightened policy over the past few years.

2. The likely Fed rate cut in July shows that they made a mistake in raising rates last year.

3. The fact that unemployment has fallen to lower levels than anticipated provides further evidence that the Fed erred in raising rates.

4. The Fed should do a full 50 basis point cut in July, not a measly 25 basis point cut.

I believe the fourth claim (the “conclusion”) is true, but I don’t get to this place via the same path as many “doves”. I do not accept the first three claims (the “premises”).

1. Monetary policy has actually eased since Trump was elected, as evidenced by a significant speed-up in NGDP growth.

2. A rate cut in July does not show that the previous rate increases were mistaken (although they may have been mistaken for other reasons.) Interest rates should go up and down with changes in the equilibrium rate, and there is abundant evidence that the equilibrium interest rate did indeed rise in 2017-18, and that this rate is now falling. The Fed should probably not be targeting interest rates at all, but if they insist on doing so then it’s appropriate to raise and lower the interest rate target along with changes in the equilibrium rate.

3. The 100 basis point fall in the unemployment rate over the past couple of years is not evidence that money was too tight a year or two ago. Unemployment fell in the late 1960s, and no one in their right mind would say money was too tight in the late 60s.

Some argue against any rate cut on the grounds that the economy is booming, and in the past the Fed did not generally cut rates when the economy was strong. Perhaps we don’t need to ease policy right now, but even in that case I’d advocate an interest rate cut, because the Fed needs to cut rates just to keep the stance of monetary policy at its current level.

But I’d go even further. The fact that inflation has been mostly running below 2%, and is expected to continue running below 2%, suggests the need for the Fed to “get ahead of the curve” with a greater than expected monetary easing. That’s why I favor a 50 basis point cut.

BTW, I don’t favor inflation targeting, but if the Fed is going to adopt a symmetrical 2% PCE inflation target, then they need to produce that inflation rate, on average.

PS. Don’t say, “The 1960s were different, because today there is no inflation problem”. That’s my point. The unemployment rate isn’t the number to look at; it’s the low inflation today that tells us that money has been a bit too tight.


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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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