Today’s payrolls number is in some ways irrelevant to the future fortunes of the dollar. The employment picture has been improving, and yet market expectations have pushed back the first Fed hike, with it now priced by October. In the wake of the oil price collapse, the focus has instead turned to inflation. Of course, a weaker number today, sub 200, would kick start worries that the Fed will be following the easing path laid out by every other central bank. But we won’t know their reaction function for sure until the set piece events of the next 6 weeks: Yellen’s semi-annual testimony and the FOMC meeting of March 19th.
Yesterday saw the release of a new paper that might shed some light on Yellen’s thinking. It is the first paper by Thomas Laubach since he was appointed the Fed’s Head of Monetary Affairs in January. He’s a significant appointment, because this is the division that is central to the planning of monetary policy. His appointment was seen as Yellen being able to appoint ‘her man’ at a time when the Fed are starting to think about the exit. Laubach was so instrumental in helping put together Yellen’s “optimal control” policy that she thanked him in her 2012 speech on the policy.
“Optimal control”, for those who may lead more exciting lives than Blondemoney’s inner central bank geek, was a policy that suggested you could exercise control over variables such as inflation, purely by the way you conduct and communicate monetary policy. Initially the models suggested that you keep rates lower for longer, and let inflation potentially rise in the long-run, so that unemployment remains low. However an update of this model last October suggested that rates needed to be going up already, because although inflation is sticky on the downside, it might also be sticky on the upside and hard to bring under control. So, get the hikes in now, then do fewer later (which was always the argument of the hawks at the Bank of England):
This new paper by Laubach, “The Macroeconomic effects of the Federal Reserve’s Unconventional Monetary Policies”, contains the following conclusions:
1. We haven’t yet felt the full impact of all of the QEs. The boost to employment is only expected to peak this quarter, while the boost to inflation isn’t expected to peak until early next year!
‘The peak unemployment effect—subtracting 1¼ percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions—does not occur until early 2015, while the peak inflation effect—adding ½ percentage point to the inflation rate—is not anticipated until early 2016′
2. It took so long for the stimulus to feed through because people kept expecting the recovery to come through sooner, and were disappointed
‘The net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case’
3. But the good news is that people will have learnt from this episode (!) and next time, as long as the Fed are credibly committed to a big response, will adjust their expectations immediately. So the economy will improve more quickly. Here’s their charts of GDP, unemployment and inflation in the absence of all the QEs, then with expectations from 2013 applied in 2009:
GDP would have headed back to 4% and only just dipped below 2%; unemployment would have come down quicker, and inflation would not be so depressed.
So what can we conclude from all this?
– If you want to make an impact: Go early, go big, and be credible.
– For Fed policy from here? There is still a boost to inflation feeding through the system, so if you think we are reaching the lows of inflation now, next year will be even higher inflation than you thought.
The question for the FOMC remains: do you wait, and run the risk of doing much more later? Or go early, and do less. Fortune favours the brave, but we’ll see just how brave Janet Yellen is in her semi annual testimony!