Tim Duy's Fed Watch

What About Inflation?

I find Binyamin Applelbaum's Fed preview to be rather depressing and distressing.  Applelbaum begins with a solid insight - reducing the unemployment rate is not the same as maximizing employment:

The Federal Reserve is making modest progress in its push to reduce the unemployment rate. But that is not the jobs goal Congress actually established for the Fed. The central bank is supposed to be maximizing employment. And on that front, it is not making progress.

Applelbaum points to the employment to population ratio as evidence that the Fed is falling short of the mandate.  But are Fed officials ready to do more? No:

There is little sign, however, that Fed officials are considering an expansion of their four-year-old stimulus campaign as the Fed’s policy-making committee prepares to convene Tuesday and Wednesday in Washington.

Applelbaum notes that the recent flow of data has forced monetary policymakers to back away from talk of ending large scale assets purchases.  But among the reasons to avoid expansion of the program we find this:

Another reason the Fed is not embracing new measures is that it already has tied the duration of low interest rates to the unemployment rate. The Fed said in December that it intended to hold interest rates near zero at least as long as the unemployment rate remained above 6.5 percent, provided that inflation remained under control. The theory is that the economy will get as much stimulus as it needs.

But what if the inflation rate is persistently below the target?  Or, worse, trending lower?  Clearly then the economy is not getting the stimulus it needs.  If we are missing on both targets, then the economy needs more stimulus.  And while we can debate the efficacy of monetary policy in influencing the pace of employment growth, surely monetary policy can influence the inflation rate.  Correct?

The distressing part of this article is that it reads as if the Fed has given up not only on its ability to influence the pace of employment growth, but also on its ability to influence the inflation rate.  Or, possibly worse, that the Fed is simply no longer concerned with the inflation rate now that the obvious threat of deflation has passed.  This again feeds suspicion that the Fed's 2 percent target is really an upper bound.  

Bottom Line:  The Fed is supposed to have a dual mandate.  Dual, as in two.  Maximum employment and price stability.  One would think that failing at the latter would be at least as important as failing at the former.  Perhaps we are learning that the Evan's rule is flawed - it should not be about only conditions before which the Fed considers removing stimulus, but also conditions by which the Fed deliberately considers adding additional stimulus. A two-side Evan's rule is needed.

Just a Few Weeks Makes a World of Difference

The minutes of the last FOMC meeting, concluded on March 20, included this passage:

In light of the current review of benefits and costs, one member judged that the pace of purchases should ideally be slowed immediately. A few members felt that the risks and costs of purchases, along with the improved outlook since last fall, would likely make a reduction in the pace of purchases appropriate around midyear, with purchases ending later this year. Several others thought that if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end. Two members indicated that purchases might well continue at the current pace at least through the end of the year.

The center of the FOMC appeared to be shifting toward agreement that large scale asset purchase program would likely be wrapped up by year end.  Of course, they included a caveat:

It was also noted that were the outlook to deteriorate, the pace of purchases could be increased.

Since the last FOMC meeting, it has become clear that the economy continues along a suboptimal path, as illustrated by the disappointing 2.5 percent GDP growth for the first quarter; just a few weeks ago, Macroeconomic Advisors was anticipating a 3.6 percent growth rate.  In addition, both employment and manufacturing reports have been less than impressive (see Calculated Risk for his take on today's Dallas Fed numbers and the implications for the ISM report).  Moreover, fiscal austerity continues to bite:

The end result is that investors have concluded, rightly, that FOMC members looking forward to cutting the pace of purchases by mid-year were overly optimistic.  Consequently, the 10-year yield was bid down to just 1.67 percent this afternoon, well below the 2.05 in early March.

Probably more important, at this juncture is that disinflation is again evident, with headline and core PCE up just 1.0 and 1.1 percent, respectively, compared to last year:

In an April 17 Wall Street Journal interview, St. Louis Federal Reserve President James Bullard highlighted the possibility that a deteriorating inflation trend might require additional easing. Other policymakers have joined him in this concern.  From Bloomberg:

“I’d of course be giving serious thought” to additional stimulus if disinflation persists, Richmond Fed President Jeffrey Lacker, who voted against the bond program last year, said last week -- while adding he doesn’t think that will happen. The Minneapolis Fed’s Narayana Kocherlakota also said this month weaker inflation may be reason to consider more accommodation.

The important point is that low inflation prompts concern even among policymakers who think the Fed can have little impact on employment growth.  For this group, high unemployment is distressing but not actionable.  But low inflation is both distressing and actionable.  Thus, at a minimum, the low inflation numbers should push the FOMC back to avoiding a premature end to quantitative easing.  In addition, it is easy to argue that the Fed should be thinking about additional easing.  Not only are they missing on the employment mandate, but increasingly it looks like they are missing on the price stability mandate as well.  A policy failure all around.

Bottom Line:  The FOMC statement should shift to indicate the softer economy and falling inflation numbers; I am watching for how much emphasis they place on the latter as a signal as to the likelihood of easing further in future meetings.  Like most, I don't anticipate an expansion of the program at this juncture.  I doubt the FOMC would see the current data as justifying a leap from thinking about ending the program to expanding the program just six weeks later.  It would be interesting if Kansas City Federal Reserve President Esther George pulls her dissent.  Her objection has been that the Fed's policy stance risks financial stability for little economic benefit.  Pulling her dissent in response to falling inflation would signal that disinflation concerns run deep in the FOMC.

Monetary Policy and Financial Stability

I think it is difficult to ignore the role of asset prices in the dynamics of the past two business cycles:

If the objective of monetary policy is a combination of low inflation and unemployment, I think it is difficult to argue that the Federal Reserve pursued an overly loose policy stance in the periods of the internet and housing bubbles.  Indeed, it is arguable that asset price bubbles were integral in fostering low unemployment.  

With this in mind, consider this conclusion from Minneapolis Federal Reserve President Narayana Kocherlakota, speaking at the 22nd Annual Hyman P. Minsky conference:

In this way, unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity. All of these financial market outcomes are often interpreted as signifying financial market instability. And this observation brings me to a key conclusion. I’ve suggested that it is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low. I’ve also argued that when real interest rates are low, we are likely to see financial market outcomes that signify instability. It follows that, for a considerable period of time, the FOMC may only be to achieve its macroeconomic objectives in association with signs of instability in financial markets.

This sounds like Kocherlakota believes that it is not possible for the Federal Reserve to accomplish its dual mandate in the absence of asset bubbles, excessive credit growth, etc.  This leads to issue of how should the Federal Reserve deal with such instability:

To answer this question, the Committee will need to confront an ongoing probabilistic cost-benefit calculation. On the one hand, raising the real interest rate will definitely lead to lower employment and prices. On the other hand, raising the real interest rate may reduce the risk of a financial crisis—a crisis which could give rise to a much larger fall in employment and prices. Thus, the Committee has to weigh the certainty of a costly deviation from its dual mandate objectives against the benefit of reducing the probability of an even larger deviation from those objectives.

In other words, if they raise interest rates, the will clearly deviate from their objectives, but if they don't there is only a chance of suffering a larger deviation.  So they should refrain from addressing financial instability (through raising interest rates) until it is clearly evident that it poses a significant risk to the dual mandate.

But how might one measure financial instability?  A new paper by Claudio Borio, Piti Disyatat, and Mikael Juselius offers a fresh look at potential output that incorporates information about the financial cycle.   Note that traditional measures of potential output focus on the inflationary consequences of level of actual output.  If inflation remains contained or falling, then by definition actual output is equal to or less than potential output.  Borio et al, however, note that the economy may be on an unsustainable path even when inflation remains contained.  Arguably, measures of potential output should incorporate information about financial factors that might signal the economy is on such a path.  

Why might be expect that we might be on a unsustainable path even under conditions of low and stable inflation?  The authors summarize:

There are at least four reasons for this. One is that unusually strong financial booms are likely to coincide with positive supply side shocks (eg Drehmann et al (2012))....A second reason is that the economic expansions may themselves weaken supply constraints. Prolonged and robust expansions can induce increases in the labour supply, either through higher participation rates or, more significantly, immigration....A third reason is that financial booms are often associated with a tendency for the currency to appreciate, as domestic assets become more attractive and capital flows surge. The appreciation puts downward pressure on inflation. A fourth, underappreciated, reason is that unsustainability may have to do more with the sectoral misallocation of resources than with overall capacity constraints. The sectors typically involved are especially sensitive to credit, such as real estate.

Thus, unsustainable financial booms can be especially treacherous, as it is all too easy to be lulled into a false sense of security. Economic activity appears deceptively robust. Financial and real developments mask the underlying financial vulnerabilities that eventually bring the expansion to an end...

The author's estimate what they describe as "finance neutral" output gaps via an expanded version of an H-P filter.  Among their findings is that applying a Taylor rule to their output gap suggests that the Federal Funds rate was set too low during much of the 2000's, and possibly now as well.  Still, the authors stop short of advocating that interest rate policy should be used to lean against financial headwinds.  Tighter monetary policy might ease financial instabilities, but aggravate recovery from a balance sheet recession.  

Arguably, the current environment is a case where it would be imprudent to lean against potential financial instabilities.   The Federal Reserve is holding interest rates low for a protracted period and thus fueling fears they are laying the groundwork for the next financial crisis.  But raising rates doesn't seem like an appropriate option considering the economy is far from fully recovered from the recession.  This speaks to Kocherlakota's comment.  And those of Federal Reserve Chairman Ben Bernanke as said in a recent speech:

One might argue that the right response to these risks is to tighten monetary policy, raising long-term interest rates with the aim of forestalling any undesirable buildup of risk. I hope my discussion this evening has convinced you that, at least in economic circumstances of the sort that prevail today, such an approach could be quite costly and might well be counterproductive from the standpoint of promoting financial stability. Long-term interest rates in the major industrial countries are low for good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low. Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading--ironically enough--to an even longer period of low long-term rates. Only a strong economy can deliver persistently high real returns to savers and investors, and the economies of the major industrial countries are still in the recovery phase.

Admitedly, this is frustrating.  It is as if we we are faced with a tradeoff between economic recovery and financial stability.  But this begs an even greater question.  Why do we have to make this tradeoff?  Why is maintaining full-employment dependent on destabilizing asset bubbles?  Commenting on this speech, Ryan Avent asks if the current dynamics are a result of the Fed's never-ending pursuit of low inflation:

...one very clear implication...price stability is keeping nominal rates low and is therefore an impediment to financial and macroeconomic stability. One has to weigh costs and benefits, of course, but one cannot miss the trade-off: the more you worry about low rates the less low and stable inflation should look like a good thing...

...It is perhaps premature to declare the existence of a new monetary trilemma, that over the medium-term central banks can choose at most two of the following: low inflation, low unemployment, and financial stability. But if Mr Bernanke continues arguing this effectively in favour of higher inflation, we may need to ask why he isn't pursuing it as an explicit goal.

Has the pursuit of low inflation brought us to a point where we can maintain the Fed's dual mandate only at the presence of financial instability?   That unless we allow for somewhat higher inflation, we are making a deliberate choice to follow only "inflation-neutral" measures of the output gap and ignore "finance-neutral" measures?  And, importantly, might it not be the case that the costs of somewhat higher inflation are in fact less than the costs associated with the financial instabilities that seem to be part and parcel of the current low-inflation regime?  

Bottom Line:  If Kocherlakota is correct and monetary policy can only pursue the dual mandate in the context of financial - and, by extension - macroeconomic instability, then we really need to consider which part of the dual mandate needs to be loosened to reduce the reliance on financial instability.  My fear is that if Fed policy makers were asked this question, they would unanimously answer that it is the full-employment portion of the mandate that should be jettisoned.

Three Parts to Macro Policy

The G20 has accepted Japan's policy approach.  From the Financial Times:

The yen fell sharply against other major currencies on Friday after the Japanese finance minister said Japan’s monetary policies had not met with resistance at the G20 group of nations in Washington. 

This interpretation of the meeting helped sink the Yen to almost 100.  More specifically, from the statement:

In particular, Japan’s recent policy actions are intended to stop deflation and support domestic demand.

Still, there remains a pro-austerity contingent:

Japan should define a credible medium-term fiscal plan.

I think the only credible medium-term plan for fiscal consolidation first involves higher near-term growth.  More broadly than just Japan, but including Japan:

We will continue to implement ambitious structural reforms to increase our growth potential and create jobs.

How do these pieces fit together?  I tend to see room for all three policy tools - monetary, fiscal, and structural - in fighting weak growth and outright recessions, although the weighting will vary according to circumstances.  For instance, I don't deny the need for structural changes in the European periphery or Japan.  Those changes, however, need to be cushioned with expansionary monetary and fiscal policy to yield a positive growth trajectory.

With this in mind, consider this recent post by Ed Harrison.  He expands the Reinhart/Rogoff debate to current events in Japan:

This is the takeaway in Japan: stimulus without reform leads to a policy cul-de-sac. Monetary and fiscal stimulus is not a cure-all for economies or Japan would be the model and it most assuredly is not the model. If you want to use stimulus, then you need to have reform policies as well. It’s a three-pronged approach. The supply side matters. And that is the promise of Abenomics, isn’t it: fiscal and monetary stimulus as bridges to sustainable growth due to economic reform. Supposedly, this is what Abenomics is all about. And the Wall Street Journal told us yesterday that this reform, the third leg of this stool is now being put into place. Be sceptical, of course. Let’s just see what happens. 

Mixing the RR debate and the Japanese and European experiences leads him to these conclusions:

Take a cue from Japan. The lesson is not to stimulate and deficit spend like mad and hope this succeeds in reflating the economy. That’s just a risk shift onto the public balance sheet. And the Japanese experience shows that people are uncomfortable with these kinds of deficits and will always work to reduce them irrespective of the consequences. You need supply side fixes too.

Take a cue from the euro zone. The lesson is also certainly not to undergo painful – and front-loaded – austerity like the euro zone. The Europeans have tied their hands with the euro. There is no currency sovereignty there and the ECB is legally forbidden to be politically aligned with any national government. The threat of insolvency is real. But Britain doesn’t have to go down this path. They have a lot more policy space. The bond vigilantes are a myth.

Read the post for more good insights.

Accepting Failure

It is starting to look like European policymakers have given up trying.  Bundesbank President Jens Weidmann, via the Wall Street Journal:

"Overcoming the crisis and the crisis effects will remain a challenge over the next decade," he said in an interview from his conference room at Bundesbank's headquarters overlooking Frankfurt's financial district, contrasting recent comments from European Commission President José Manuel Barroso that the worst of Europe's crisis is over.

Also from the Wall Street Journal:

An aging society and the time needed to work through its debt crisis will keep growth in Europe subdued for years to come, German Finance Minister Wolfgang Schaeuble said Friday.

“No one should expect that Europe will deliver high growth rates for years,” he said.

Apparently the new strategy is to keep expectations low.  One has to imagine that given the current path of activity and the lack of fiscal support from European nations, the European Central Bank will find itself not only cutting rates but implementing its own version of quantitative easing by year end.  The only other option would be to sit back and watch Europe slide from recession to depression.  And that does not seem like a credible policy path.

Bullard Concerned About Low Inflation

St. Louis Federal Reserve President James Bullard sees inflation as a potential problem, but not in the way you might think.  From the Wall Street Journal:

Federal Reserve Bank of St. Louis President James Bullard said Wednesday inflationary pressures may be growing too weakly and if they soften further, the central bank may have to boost its asset buying to bring price pressures back up to more desirable levels.

“Inflation is running very low” as measured by the personal consumption expenditures price index, the Fed’s favored inflation gauge, the policymaker said. “I’m getting concerned about that,” he said.

“If inflation [gains] continues to go down, I’d be willing to increase the pace of purchases” of bonds the Fed is now engaged in, Mr. Bullard said. “This is not what I expected, and I think inflation should be closer to the target than it is,” the official said, adding he considers it just as important to defend the Fed’s 2% inflation target from the low side, as it is to keep prices from going over 2%.

This is the problem:

With the Fed's preferred inflation target trending down, it seems a little silly to start talking about ending the asset purchase program.  Indeed, as Bullard suggests, there might be room to expand it further.  Note also that Bullard comes to this conclusion despite his concern that monetary policy has limited ability to create jobs, the main point of his speech.  See the Wall Street Journal article cited above or Neil Irwin for more. 

While everyone is busy watching the labor market for signs that the Fed can wind down asset purchases, we tend to forget that inflation should be part of the equation as well.  From the most recent FOMC statement:

The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.

The phrase "in the context of price stability" should cut both ways.  The Fed might need to tighten policy even if the labor market is not improving if inflationary pressures start to emerge.  But at the same time, it should also mean that the Fed may need to increase the pace of asset purchases even if the labor market is improving.  That seems to be the current situation, yet we hear alot of Fedspeak suggesting a widespread inclination to end asset purchases this year regarless of the recent bout of disinflation.

That said, inflation might be set to tick up in the months ahead.  From MIT's Billion Prices Project:

Not a worrisome move, but enough to suggest that Bullard's low inflation concern might be short-lived.

Bottom Line:  Bullard reminds us the exit from the asset purchase program should not be simply a function of labor markets, but also a function of inflation.  And the current path of inflation does not indicate that policymakers should be rushing ahead with a plan to end QE this year. 

More Reinhart and Rogoff

The Reinhart and Rogoff rolled through the internet today like a tsunami.  Peter Coy at Bloomberg:

The point and counterpoint of academic debate that once occurred over months or years has been compressed to mere hours by social media. Today the Twitterverse exploded with chatter about a new research paper claiming to find holes in a landmark academic paper that’s been cited to justify extreme austerity measures. By mid-afternoon the authors—Harvard economists Carmen Reinhart and Kenneth Rogoff—had emailed reporters a quick reply defending their work.

I first saw the Mike Konczal's post.  More excellent commentary came from Tyler Cowen, Dean Baker, Jared Berstein, and FT Alphaville.  Joe Weisenthal reminded us on Twitter that he was never an RR fan.  While some like Cowen argue that the case for austerity did not rest on Reinhart and Rogoff themselves, Tim Fernholtz has an impressive list of policymakers who use the paper as what they see as clear and convincing evidence for austerity now.  

For their part Reinhart and Rogoff responded, concluding that the new results are very similar to their own:

These results are, in fact, of a similar order of magnitude to the detailed country by country results we present in table 1 of the AER paper, and to the median results in Figure 2.  And they are similar to estimates in much of the large and growing  literature,  including our own attached August 2012 Journal of Economic Perspectives paper (joint with Vincent Reinhart) .  However, these strong similarities are not what these authors choose to emphasize.

They also claim they were very careful about distinguishing between causality and correlation:

By the way, we are very careful in all our papers to speak of “association” and not “causality” since of course our 2009 book THIS TIME IS DIFFERENT showed that debt explodes in the immediate aftermath of financial crises.

Which brings this comment by Dan Davies:

once more, from the compliance department - knowingly allowing a very misleading view of your research to persist is not OK either.

One thing's for sure - this isn't the end of this debate.  Back to Coy:

This isn’t an obscure academic debate. As Krugman points out, the Reinhart-Rogoff research is one of the two main threads in the pro-austerity argument, the other being Harvard’s Alberto Alesina on the macroeconomic effects of austerity. With so much at stake, the argument that caught fire in one afternoon is likely to keep burning for months.

 There will definitely be more to come.

Yellen and the Reach for Yield

Federal Reserve Vice Chair Janet Yellen, speaking at the IMF "Rethinking Macro Policy II" conference, notes that Fed policy is intended, at least in part, to increase risky-taking behavior:

Some have asked whether the extraordinary accommodation being provided in response to the financial crisis may itself tend to generate new financial stability risks. This is a very important question. To put it in context, let's remember that the Federal Reserve's policies are intended to promote a return to prudent risk-taking, reflecting a normalization of credit markets that is essential to a healthy economy. 

Certainly some reflation of asset prices is helpful in healing household balance sheets and thus   But she and other realize that it can go too far: 

...Obviously, risk-taking can go too far. Low interest rates may induce investors to take on too much leverage and reach too aggressively for yield. I don't see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability. But there are signs that some parties are reaching for yield, and the Federal Reserve continues to carefully monitor this situation.

It would be hard not to make this conclusion given the role of asset bubbles in the dynamics of the last two business cycles.  Still, what is the right policy response?  Yellen:

However, I think most central bankers view monetary policy as a blunt tool for addressing financial stability concerns and many probably share my own strong preference to rely on micro- and macroprudential supervision and regulation as the main line of defense.

The center of gravity at the Fed remains wary of using interest rates to temper suspected asset bubbles, excessive leverage, etc.  They prefer the idea of using supervision and regulation.  One little problem though:

The Federal Reserve has been working with a number of federal agencies and international bodies since the crisis to implement a broad range of reforms to enhance our monitoring, mitigate systemic risk, and generally improve the resilience of the financial system. Significant work will be needed to implement these reforms, and vulnerabilities still remain.

No, we don't have the tools in place.  And, I would add, regulators will be continuously playing catch-up on the regulatory front.  Consequently, the ball might fall in the monetary policy court:

Thus, we are prepared to use any of our many instruments as appropriate to address any stability concerns.

Which leaves me a thinking that although the Fed might not want to use monetary policy to blunt any suspected financial stability risks, they may find themselves in a place where they believe they have no other choice because alternative tools are not available.  

Not an immediate issue, but one to keep an eye on.  The Fed is not likely to be so dismissive of financial stability risks the next time around.

Another Spring Slowdown?

While expectations for a solid first quarter GDP report are running high, the most recent data flow has been somewhat sloppy.  Sloppy enough that it should raise red flags for monetary policymakers pushing to end QE by the end of this year.

In addition to the weak employment report for March, the ISM manufacturing index retreated:

In contrast, the industrial production report appeared to signal ongoing strength:

 

But the details suggest a loss of momentum in March aside from a temporary boost from utilities:

Manufacturing output edged down 0.1 percent in March after having risen 0.9 percent in February; the index advanced at an annual rate of 5.3 percent in the first quarter. Production at mines decreased 0.2 percent in March and edged down in the first quarter. In March, the output of utilities jumped 5.3 percent, as unusually cold weather drove up heating demand.

More disconcerting was the retail sales report, which signaled that the recent strength in consumer spending is waning:

Indeed, this is not terribly unexpected as it likely reflects the impact of higher tax this year.  But it is a signal that one should be cautious before extrapolating Q1 GDP numbers.  On a more positive note, housing starts were higher, with much of the improvement stemming from multifamily construction:

The solid improvement in housing starts seems at odds with waning builder confidence, but that may have more to do with supply constraints than demand.  From the news release:

“Many builders are expressing frustration over being unable to respond to the rising demand for new homes due to difficulties in obtaining construction credit, overly restrictive mortgage lending rules and construction costs that are increasing at a faster pace than appraised values,” said Rick Judson, National Association of Home Builders (NAHB) Chairman and a home builder from Charlotte, N.C. “While sales conditions are generally improving, these challenges are holding back new building and job creation.”

“Supply chains for building materials, developed lots and skilled workers will take some time to re-establish themselves following the recession, and in the meantime builders are feeling squeezed by higher costs and limited availability issues,” explained NAHB Chief Economist David Crowe. “That said, builders’ outlook for the next six months has improved due to the low inventory of for-sale homes, rock bottom mortgage rates and rising consumer confidence.”

This suggests the improvement in housing demand is just beginning to have an impact on the overall economy.  That impact will accelerate as supply chains rebuild over the next year.

On net, I think the data is telling us a familiar story:  The positives in the US economy are difficult to ignore.  Housing starts are a very good indicator of the direction of the economy, and that direction appears to be up.  But it doesn't pay to get too carried away with any one quarter's worth of data.  Underlying growth has been slow and steady since the end of the recession, with positive quarters offset by negative quarters.  And the impact of tighter fiscal policy looks likely to produce a similar trend this year.  The light at the end of the tunnel, however, is that as the fiscal effect fades toward the end of this year and into next, activity could finally see a more of the sustained improvement we have been looking for.

But, at the moment, that sustained improvement looks ephemeral.  That is the message of the bond market as yields plunged back to the 1.7 percent range since the beginning of the year.  And the beat-down of commodity prices indicates nervousness on the global outlook as well.  If I was a monetary policymaker, I would be paying attention, especially as the inflation numbers are not telling us that imminent tightening is necessary:

Consumer price inflation (not the Fed's preferred measure) posted a -0.2 percent headline decline in March and a slight 0.1 percent core gain.  Inflation?  What inflation?  

Some FOMC members seem to be paying attention to the change in the tone of the data.  New York Federal Reserve President William Dudley noted his concerns in a speech today:

In terms of the labor market, we have seen only a moderate improvement in labor market conditions over the past six months or so. After an encouraging pick up in the pace of job creation around the turn of the year, the employment report for March showed a gain of only 88,000 jobs. While I don’t want to read too much into a single month’s data, this underscores the need to wait and see how the economy develops before declaring victory prematurely.  I’d note that we saw similar slowdowns in job creation in 2011 and 2012 after pickups in the job creation rate and this, along with the large amount of fiscal restraint hitting the economy now, makes me more cautious....

...In the near term, there is considerable uncertainty about the outlook, particularly because the multiplier effects from fiscal drag and sequestration are still unclear. This uncertainty should gradually decline—for better or for worse—over the coming months, as the sequester’s impact takes hold and more economic data come in, giving us a clearer picture of the forward momentum of the economy....

...I see the current pace of asset purchases as appropriate.

At some point, I expect that I will see sufficient evidence of improved economic momentum to lead me to favor gradually dialing back the pace of asset purchases.  Of course, any subsequent bad news could lead me to favor dialing them back up again.

Notice that he does not suggest, as others do, that it would be appropriate to end quantitative easing by the end of this year.  Chicago Federal Reserve President Charles Evans expressed his belief that quantitative easing would stretch into 2014:

Mr. Evans told reporters after a speech in Chicago that he expected “with a high probability” that bond buying would continue into the fall. He added he “would not be surprised” if a wind-down carried over into 2014, though offered an upbeat assessment of the economy’s current trajectory and saw no immediate inflation threat.

Prior to the discussion about ending the QE this year, my outlook had been similar to Evans' - the tapering-off procees would begin late this year after the impact of fiscal contration had passed, with a likely end in the first half of 2014.  But recent Fedspeak has convinced me that a sizable contingent of policymakers are looking to end QE sooner than later; I suspect that contingent has fallen back to concerns about size of the balance sheet rather than the pace of the recovery.

Bottom Line:  The data flow is not as uniformly positive as it seemed just a month ago.  Arguably, we are experiencing yet another spring slowdown.  This should trigger some monetary policymakers to reassess their predictions that QE could be safely terminated at the end of this year.  But there may be a contigent that has dug in its heels on the issue and are asking themselves "how bad does the data have to get to continue assets purchases" rather than "how good does the data need to be to end asset purchases?"  Of course, ultimately the answer will depend on which of these two questions Federal Reserve Chairman Ben Bernanke is asking.

Austerity Research Fail

Going viral on Twitter is Mike Konczal's post on the infamous Reinhart and Rogoff paper - the paper that has been cited over and over again in support of austerity policies across the world.  Konczal reveals a recent effort to replicate the Reinhart/Rogoff results by Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts, Amherst.  The conclusion:

They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don't get their controversial result....

...So what do Herndon-Ash-Pollin conclude? They find "the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as [Reinhart-Rogoff claim]." Going further into the data, they are unable to find a breakpoint where growth falls quickly and significantly.

The supposedly-obvious causal link between debt and growth is more ephemeral than many would like to believe.