The IMF wants us to make another policy error with interest-rates

This week the monetary policy great and the good or rather those who consider themselves to be the great and the good have decamped to the ECB Forum at Sintra in Portugal. The opening salvo was fired by IMF Deputy Managing Director Gita Gopinath over dinner. So I suppose some were busy sampling the delights of the ECB wine cellar. But for those who were capable of listening properly the speech was revealing in what it did not say as what it did. For example there was this.

The first uncomfortable truth is that inflation is taking too long to get back to target. This means that central banks, including the ECB, must remain committed to fighting inflation despite risks of weaker economic growth.

Rather curiously she opened by pointing out that her own forecasts have been useless.

Inflation forecasters have been optimistic that inflation will revert quickly to target ever since it spiked two years ago. As you can see, this includes the ECB and the IMF,
whose forecasts are nearly indistinguishable.

Next up she seems to only have a weal grasp of the issue of monetary policy lags.

First, while the ECB has raised interest rates during the past year by 400 basis points—the
most in its history—activity has only slowed modestly.

We know that it takes some 18/24 months for interest-rate changes to fully impact the economy so the response will take a while because many of the changes are only recent. Thus we do not need the research below especially as central banking research have proven to be of the chocolate teapot variety.

While ongoing research will shed light on why inflation has proved so sticky

Her speech is in denial about a fact which requires no research which is that the rises in interest-rates were sung about by Carole King.

And it’s too late, baby, now it’s too late
Though we really did try to make it

Here she is from September 2021 assuring us there wasn’t going to be much inflation.

What does ‘transitory’ inflation look like? Here are our projections for the US and the Euro Area (EA). Transitory is not in months, but in quarters for the US.

According to her Euro area inflation would be below target when in fact it went into double-digits. So a complete fail.

Wages and Unemployment

Next up is something which is not a little chilling. The emphasis is mine.

The ECB—and other central banks in a similar situation—should be prepared to react
forcefully to further upside inflation pressures, or to evidence that inflation is more
persistent, even if it means much more labor market cooling.

For a start we cannot have more of something we have not had yet, at least according to her.

The unemployment rate is at
historic lows. Wage growth has been solid and is picking up,

There are a couple of mentions of real wage falls but they feel like throwaway lines.

Given the massive decline in real
wages since the pandemic, some wage catchup is to be expected.

Then we get to the blame game. First it is the fault of firms.

All else equal, if inflation is to fall quickly, firms must allow their profit margins—which have shot up during the past
two years—to decline and absorb some of the expected rise in labor costs. But firms may resist this, especially if the economy remains resilient,

Then it is the fault of workers.

while workers may demand payback for their real wage losses. Such dynamics would slow inflation reduction and likely feed into expectations and increase susceptibility to further upside cost or resource pressures.

There does not seem to be a section covering how the supposed experts like here got this so wrong.Nor a section covering how these are developments caused by the failures of her and others.

What is her suggested policy?

Ms.Gopinath gives a hint here.

What is worrisome is that sustained high inflation could change inflation dynamics and make the task of bringing inflation down more difficult.

In itself that is true although there is still no real admittall of the mistakes which led to it. Then we get to it.

With underlying inflation high and upside inflation risks substantial, risk management considerations in the euro area suggest that monetary policy should continue to tighten and then remain in restrictive territory until core inflation is on a clear downward path.

So in spite of the fact that she has told us the speed of the interest-rate rises have been unprecedented meaning that we still have quite a bit of lag time to work through she wants ever more. How much “labour market cooling” does she want? An easy thing to call for when you are in a cosy position in an organisation where it will not apply to you.

There is a nuance here in that we see an old friend “core inflation” and I mean an old friend via the Paul Simon definition.

Hello darkness, my old friend
I’ve come to talk with you again

What I mean by that is that Gita Gopinath has demonstrated over the past couple of years that she has not grip on inflation trends. So moving to a derivative of it is even worse. Indeed it sets the ground for another policy error and this has been reinforced at Sintra today.

“I’d see a need to cut rates when it becomes quite certain that inflation is about to start significantly and persistently undershooting our target of 2%,” he said. “And not at the end of the forecast period but towards the middle of the forecast period.”

That was from Martins Kazaks who is head of the Latvian central bank. He is reinforcing the view that interest-rates should be held high to respond to past events. Indeed with his “persistently undershooting” quite a bit in the past. So he will be applying a brake to the economy when he has no idea whether that is the right thing to do or not and the odds are that it will not be.

Comment

The thing that is persistent is in fact the failures of these people.At least when politicians had the job of monetary policy we could vote them out. But now policy seems to be set more to cover up their past failures than to achieve anything. As I noted earlier “labour market cooling” is a potentially chilling phrase. I could go further and say that after its own record the IMF has quite a cheek in trying to tell others what to do.

But there is more because as it tries to lecture us on inflation the IMF id also trying to raise it.

Interesting to hear IMF deputy managing director Gita Gopinath talking about the risk of a “disorderly [energy] transition” and showcase a chart with the tittle: “The climate transition [is] likely to be mildly inflationary, even with budget-neutral policies” ( @JavierBlas)

So far it has been very inflationary….

The establishment seem very keen to tell us that US interest-rates are going higher

One of the major economic stories of last year was the rise in US interest-rates. The US Federal Reserve is keen to tell us it was rapid but the main issue was sung about by Carole King.

And it’s too late, baby, now it’s too late
Though we really did try to make it
Somethin’ inside has died

Monetary policy is supposed to get ahead of events due to the lags in the system a subject I will return to. But instead we got a central bank chasing inflation’s rise rather than getting ahead of it. A consequence of the move was that we saw a strong US Dollar last year, which via its role as the reserve currency in which commodities are priced. made inflation worse for everyone else.

Let us remind ourselves of where things stand.

In support of these goals, members agreed to raise the target range for the federal funds rate to 4¼ to 4½ percent.

Last night’s Fed ( FOMC) Minutes contained some rather aggressive rhetoric.

In discussing the policy outlook, participants continued
to anticipate that ongoing increases in the target range
for the federal funds rate would be appropriate to
achieve the Committee’s objectives.

Not so much that bit but more this.

A number of participants emphasized that it would be important to clearly communicate that a slowing in the pace of rate increases was not an indication of any weakening of the Committee’s resolve to achieve its price-stability goal or a judgment that inflation was already on a persistent downward path,

Then here.

Participants generally indicated that upside risks to the
inflation outlook remained a key factor shaping the outlook for policy

As to rate cuts well we got an official denial.

No participants anticipated that it would be appropriate to
begin reducing the federal funds rate target in 2023.

Apart from the track record of official denials there is also the track record of the Federal Reserve in forecasting the future!

As ever the rhetoric is contradictory as one the one hand.

In view of the persistent and unacceptably high level of inflation, several participants commented that historical experience cautioned against
prematurely loosening monetary policy.

But on the other rather than being rigid it needs to be flexible.

Participants generally noted that the Committee’s future decisions regarding policy would continue to
be informed by the incoming data

The message overall is that they intend to keep raising interest-rates.

Neel Kashkari

The President of the Minneapolis Fed wrote a piece on Medium yesterday. There were several things we could take from it. Firstly he got things very wrong.

To state clearly, I was solidly on “Team Transitory,” so I am not throwing stones.

Then confesses implicitly that the Group think I accused central bankers of was true.

But many of us — those inside the Federal Reserve and the vast majority of outside forecasters — together made the same errors in, first, being surprised when inflation surged as much as it did and, second, assuming that inflation would fall quickly. Why did we miss it?

Oh and he also confesses to another criticism of mine which is preferring economic models over real world experience.

The inflation in this example is not driven by the two primary sources that traditional Phillips-curve models used by policymakers, researchers, and investors consider: (1) labor market effects via unemployment gaps, and (2) changes to long-run inflation expectations.

Actually the Phillips-curve stuff is especially poor as it was quite clear that the credit crunch changes things fundamentally for it.

If we return to the timing point I make so often Neel seems to have no idea about it at all.

While I believe it is too soon to definitively declare that inflation has peaked, we are seeing increasing evidence that it may have. In my view, however, it will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked.

This is a really big deal because in monetary policy if you wait to be “sure”, the one thing you are likely to be is wrong. This is because you have lags in the data arriving as well as lags before policy actions begin to work. But as you can see Neel is trying to present himself as a doughty inflation fighter.

Once we reach that point, then the second step of our inflation fighting process, as I see it, will be pausing to let the tightening we have already done work its way through the economy. I have us pausing at 5.4 percent, but wherever that end point is, we won’t immediately know if it is high enough to bring inflation back down to 2 percent in a reasonable period of time.

One might have reasonably thought that after confessing to the problems with economic models he should have the sense to steer clear of a precise number like that. Especially as the US does not move in sizes that get you to 5.4%. Also we got another official denial about interest-rate cuts.

Given the experience of the 1970s, the mistake the FOMC must avoid is to cut rates prematurely and then have inflation flare back up again.

International Monetary Fund

This too has weighed in on the subject via an interview with the Financial Times.

Inflation in the US has not “turned the corner yet” and it is too early for the Federal Reserve to declare victory in its fight against soaring prices, a top IMF official has warned.

You might think that with the track record of the IMF in recent years it would avoid giving advice to others. But, instead it has a policy prescription as well.

In an interview with the Financial Times Gita Gopinath, the fund’s second-in-command, urged the US central bank to press ahead with rate rises this year despite a recent moderation in headline inflation following one of the most aggressive tightening campaigns in the Fed’s history.

As you can see the Financial Times is high on the hype here with “top official” and “second-in-command”. They seem unable to stop it.

The comments from the fund’s deputy managing director

But whilst not quite as aggressive as Neel Kashkari we get to the point.

Gopinath backed the Fed’s benchmark rate rising to about 5 per cent and staying there throughout this year, in an effective endorsement of the latest “dot plot” projections from US central bank officials.

Comment

It is hard not to have a wry smile at a reality where central bankers claim to have abandoned Forward Guidance and then give us specific numbers for future interest-rates. In many ways 5.4% is as specific as they have ever got. That gets us to the crux of the issue because they actually believe that the ordinary person takes notice of them. I used to think of that as a pure fantasy but after all the errors it is more than that.

Every man has a place, in his heart there’s a space
And the world can’t erase his fantasies
Take a ride in the sky, on our ship, Fantasy
All your dreams will come true, right away ( Earth, Wind & Fire)

The only people who believe this are the central bankers and their media acolytes. In their journey towards becoming politicians they sold their souls to the idea of Public Relations. In this instance that means that if you think  you may have to reduce interest-rates later in 2023 tell everyone first about your plans to raise them. That is the road on which the Fed’s biggest “Dove” has become an apparent “Hawk”

Meanwhile if we switch to the real world we see that 2023 has started with evidence going the other way. Inflation numbers have fallen, as has the price of crude oil, China is struggling, and a mild winter in Europe has meant gas prices not as high as feared. That is why the US ten-year yield is 3.7% because it is looking ahead of the next rise ( presumably 0.25%) to what happens next?