Econ Intel Brief #1
The Fed holds rates steady; inflation continues to decline; still no recession in sight.
All,
I’ve left the Hill to finish my doctoral dissertation at George Mason University. (As some of you know, I have been working part-time on graduate school for the better part of six years.) I plan to graduate in December. My dissertation is on the effects of U.S. monetary policy.
While I don’t know what the future will bring, it has been a great honor working with all of you. I hope we’ll work together again soon. Until then, please don’t hesitate to reach out with questions, requests, suggestions, testimony opportunities, etc. Email chris@russoecon.com.
I plan to occasionally reach out with my views on U.S. economic conditions and the outlook. (Say, once a month? Less frequently than before but with more info per email.) Please forward this email to anyone interested. Subscribing is free, and you can unsubscribe at any time.
Best,
Chris
Contents
The Federal Reserve Keeps Rates Steady
The Outlook for Monetary Policy
The U.S. Economy Still Has Some Blemishes
Testimony on a 21st Century Gold Standard
Stuff to Read While Waiting for Votes
Upcoming Data to Watch
The Federal Reserve Keeps Rates Steady
At 2pm, the Federal Reserve announced that it held the target range at 5.25—5.50%. This decision was widely expected. The Fed’s statement suggests that the risks to the outlook (i.e., the risk of re-accelerating inflation vs. the risk of recession) are “moving into better balance.”
The Fed’s main inflation gauge read about 2.6% in December, the lowest since Feb 2021. As discussed in the next section, a simple Taylor rule would suggest the Fed should begin cutting.
The Fed’s statement also underscored its intent to continue passively reducing its holdings of Treasuries and mortgage-backed securities. As a quick reminder, the Fed reduces the size of its balance sheet by not reinvesting maturing securities. Since it primarily bought long-term bonds in the last few years, it takes some time for those assets to mature.
Chairman Powell’s press conference begins now (2:30pm ET).
The Outlook for Monetary Policy
A simple Taylor-type rule suggests that the Fed should begin cutting overnight interest rates. E.g., the Cleveland Fed nowcasts that—as measured by the 12-month change in the personal consumption expenditures (PCE) price index—January’s inflation rate was 2.19%. Since the Fed’s inflation target is 2%, inflation is currently running about 0.19% above target. For sake of illustration, assume the natural rate of interest is 2%. A rule prescribing a two-for-one reaction to deviations of inflation from target would prescribe an interest rate of only 2.38%.
To be clear, different rules would prescribe different interest rates. E.g., if you instead measure inflation by the 12-month change in the consumer price index (CPI), the assumptions above would instead prescribe an interest rate of 3.92%. (The Fed’s inflation target is stated in terms of the PCE price index, which tends to run a bit cooler than CPI.) There are all sorts of “what ifs” you could consider, but the decline in inflation from its summer 2022 peak suggests that monetary policy should gradually loosen.
Options-implied expectations indicate that gradual loosening, albeit slower than the simple Taylor rule would prescribe. Markets see a 50/50 chance of a 0.25% cut in March, similar cuts thereafter. While uncertainty increases as the forecast horizon lengthens, options-implied probabilities suggest the most likely target range by year-end 2024 is 3.75—4.00%.
To be clear, a “loosening” of monetary policy does not necessarily mean that monetary policy is becoming “loose.” Here, “loosening” means that policy is “tight, but becoming less so.” Again, the “natural rate of interest” concept is useful. Policy is “tight” (restraining inflation) when the overnight rate is above the natural rate. If the natural rate of interest is 2%, then lowering the overnight rate from about 5.5% to about 4.5% means that policy is still tight.
The U.S. Economy Still Has Some Blemishes
To be emphatic, just because the economy isn’t currently in a “recession” doesn’t mean that the economy is strong, or that the president’s policies are having a positive economic effect, or won’t enter a recession in the future. Here are some blemishes I worry about.
Employment
The U.S. economy has 3 million fewer jobs than predicted by the pre-pandemic trend. For native-born workers, employment is down 1 million compared to its pre-pandemic high.
Among prime-age men, 1 in 9 are not employed or seeking employment. Since 1960, the labor force participation of prime-age men has fallen by 7.9 percentage points.
Among all adult men, that share out of the labor force rises to 8 in 25. Since 1948, the labor force participation rate of all adult men has fallen by 18.5 percentage points.
Inflation
As measured by the CPI, the dollar has lost about 17.6% of its consumer purchasing power since President Biden took office. (17.3% if you prefer data before seasonal adjustment.)
Inflation was higher for lower-wage workers, who tend to spend a higher share of their income on necessities (food, energy, housing) that saw faster rates of price increases.
Income and Wages
Adjusted for inflation, income per person is down $424 compared to one year ago.
As measured by the Bureau of Labor Statistics, after adjusting for inflation, the average private-sector wage is down 2.6% since President Biden took office. (This stat has some caveats; namely, it includes lower-wage workers re-entering the workforce in the COVID recession recovery. See Chapter 1 of last year’s Joint Economic Report for info.)
Testimony on a 21st Century Gold Standard
Earlier this month, I testified before the New Hampshire House Committee on Commerce and Consumer Affairs re: the New Hampshire Sound Money Act. If enacted, the bill would create a digital alternative to the U.S. dollar backed by gold and silver. I made three key points about this proposal, which I called the “Granite coin.”
First, the dollar has lost most of its value since the U.S. left the gold standard in 1933. Ultimately, the erosion of the dollar’s value was caused by an unsustainable rise in U.S. debt, which was sometimes aided by easy money policies from the Federal Reserve.
Second, a Granite coin could offer New Hampshire citizens a hedge against inflation. By design, a Granite coin would be fully backed by a fixed quantity of underlying specie. Its purchasing power would fluctuate as gold and/or silver rose or fell in value, but competitive market forces would tend to stabilize its purchasing power over time.
Third, however, a commodity money is not a panacea for inflation. The market forces that tend to stabilize consumer prices might take years or decades to fully operate, and only if it was widely adopted. It would help if other states (e.g., Texas) took similar measures.
I concluded with the following questions to my Washington friends.
A century of inflation has made Americans skeptical of the U.S. dollar, and some are seriously considering alternatives. Will we fairly compete for the space in their wallets and restore fiscal responsibility? Or will we return to the crooked politics of financial repression and inflationary finance? The American people patiently await our answer.
My full remarks (as prepared for delivery) can be found here. Thank you to Chairman Hunt and Vice Chairman Ammon for the invitation to testify.
Stuff to Read While Waiting for Votes
Upcoming Data to Watch
Jobs Report — 2/2
CBO Budget Outlook — 2/7
CPI Inflation — 2/13
Q1 GDP (2nd estimate) — 2/28
PCE Inflation — 2/29