Edward Price is a former British economic official and current teacher of political economy at New York University’s Center for Global Affairs
As the FT’s Colby Smith reports, Federal Reserve chair Powell has basically given up on forward guidance.
Makes sense.
Forward guidance is was the practice of signalling rate decisions in advance. It rested on the central bank having some idea of what their future holds. No longer. Now, the Fed has little clue, and no conviction, about what it will do next. In other words, there are two equally plausible scenarios for the US policy rate.
Scenario one: the Fed keeps hiking aggressively. Why? To smash inflation. Obvs. This is price stability.
Scenario two: the Fed slows the pace of hikes down, even halts them. Why? To protect economic activity. Derp. This is full employment.
So the USS Federal Reserve is trapped between both headwinds and tailwinds at once. Headwinds limit the pace of future hikes; they are the squall of recession. Tailwinds encourage higher rates; they are the gale of persistent inflation. Not so much the dual mandate as a fool’s errand, rendered an impossible task by unforgiving circumstance.
All this we know. Central banks, on occasion, often drop one aim in favour of another as economics conditions change. But it also speaks to a much deeper truth. Rather than think of monetary choices as a dilemma, a trade-off between competing policy targets, we should see the death of forward guidance for what it is: a systemic dysfunction in mainstream economics.
So let’s state it clearly. There is no such thing as r-star, the natural rate of interest. There are two natural rates, one for prices (higher) and one for employment (lower). Actually, when you count the needs of financial markets, there are probably three. Markets want zero interest rates. This means there is no such thing as a functioning macroeconomics. On Wednesday the US monetary authorities basically confessed as much. There is just a complex microeconomic system they, and we, do not understand:
Here’s what Alphaville said last year about the convoluted Flexible Average Inflation Target (FAIT):
[E]xplaining the framework again and again, as Jerome Powell and others have done, doesn’t reduce the injection of uncertainty. If anything, it just provides forward guidance about the dilution, even end, of forward guidance itself.
So sure, the Fed repeated that it was going to pursue the 2 per cent inflation target in a new, super convoluted way. But that didn’t reduce the fact that FAIT was confusing. If anything, it signalled clear communications were on the way out. And they were.
Does all this mean a new level of transparency in central banks, one that admits their limitations? Or a new era of returned opacity? It matters not. Either will have the same effect: more uncertainty — and please, no more talk of a soft-landing either. How can the Fed predict that? It can’t.
Some of you may find this irritating. Some of you may still be hoping that economics makes good by Christmas and somehow delivers the world a new train set. But Macro Santa isn’t coming this year. And Macro Santa isn’t coming next year either. Because Macro Santa is dead.
Source: Economy - ft.com
