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Inflation and The Fed - February 5, 2019

Last Friday was a deluge of data. Unemployment ticked up to 4%, NFP was nearly double expectations, AHE continues to grow more than 3% YoY and ISM beat expectations nicely. Robust Consumer Sentiment and Construction Spending give hope that this strength will continue. However, this week, as the market seems to place ever-more weight on the hemming and hawing at the Fed, we want to focus on some research that is worth reading.

“NonPuzzling Behavior”

 In “The NonPuzzling Behavior of Median Inflation”, Laurence Ball and Sandeep Mazunder, of the NBER, arrive at two important conclusions using the weighted median of industry inflation rates as a measure of core inflation. First, using the weighted median helps eliminate the confusion surrounding the “mystery” of inflation behaviors, systematically undercovering “a stable level of underlying inflation by filtering out unusual industry price changes”. Second, weighted median inflation can be used in conjunction with inflation expectations to describe the unemployment-reflation relationship. Specifically, using weighted median inflation in data spanning from 1985 to 2017, the “data show a clear and robust Phillips curve that remains stable after 2008.” Problem solved! The authors note that the median “could vary significantly depending on the level of industry disaggregation”, but believe “that fewer economists would puzzle over a breakdown of the Phillips curve if the weighted median received more attention”.

 “The Case for Negative Interest Rates”

 In the game of shoulda woulda coulda of Fed policy, a recent paper by Vasco Curdia at the San Francisco Fed is firmly on the side of shoulda. In “How Much Could Negative Rates Have Helped the Recovery?”, Curdia uses a model to argue that negative interest rates would have benefited the economic recovery following the GFC. He argues first, reducing the fed funds rate below zero “would have reduced economic slack... and sped up the ensuing recovery”. Second, the extra stimulus “would have pushed inflation higher as well”. Win-win! Again, the author adds some caveats. People circumventing the negative rate (see Japanese safe sales) could mean “a negative interest rate would be less stimulative than my analysis suggests”. Nonetheless, Curdia concludes that “negative interest rates may be a useful tool to promote the Fed’s dual mandate”.

 “Self-Induced Paralysis”

 Last in our roundup is an oldie-but-goodie 1999 paper from none other than Ben Bernanke explaining how the BoJ “could help promote economic recovery in Japan”. In “Japanese Monetary Policy: A Case of Self-Induced Paralysis?”, Bernanke discusses the options available to the BoJ if they stopped hiding “behind minor institutional or technical difficulties in order to avoid taking action”. He discusses “the ‘helicopter drop’ of newly printed money” and what was then considered “nonstandard open-market operations” aka QE. Being relatively free of Fed speak and jargon, the paper is well worth a read, both for historical perspective and for a sense of just how much foreshadowing Fed writing can hold.