E Charts And History Reveal Why The Fed Must Break Stuff

There really is nothing to worry about when it comes to the Fed, unless you think things are not any different this time around. History teaches that the Fed breaks stuff, that it must break stuff. That is discussed below. Despite all the discussion that occurs below, keep this in mind. The cost of raw materials is soaring. That can be an end of cycle warning. While not all commodities are soaring, some are, like wood pulp (chart below), and nitrogen.

In watching the Fed, Professor Tim Duy and Dr. Scott Sumner seem to be in agreement regarding monetary policy. No general inflation gives the Fed breathing room according to the two economists.

DuyDuy

The minutes of the September Federal Open Market Committee meeting confirmed speculation that Federal Reserve policy makers are leaning toward pushing interest rates above levels considered to be neutral, which neither stimulate nor restrain the economy. That sounds ominous, but it is important not to worry too much yet over the prospect of restrictive policy.

Fed forecasts are a projection, not a promise. If the economy stumbles, odds are the Fed will react appropriately and ease policy. There, however, is an important exception to this rule. If inflation looks to be stirring, the Fed will likely tighten down the clamps. That’s when the real worrying should start, but the Fed does not appear near that point yet.

Sumner shared this crucial insight on his blog, the Money Illusion:

The Fed influences the economy in many ways. One method is by adjusting the policy interest rate (fed funds or IOR). A far more important way is by affecting the natural rate of interest. Thus the Fed sharply reduced the natural rate in 2008, while only gradually reducing the policy rate. To the average economist (and to Trump) the Fed was “easing” monetary policy. In fact, because the natural rate was falling even faster than the policy rate, they were tightening policy.

and:

A tight money policy (such as late 2007 through 2008) will reduce NGDP growth expectations, and this reduces the natural rate of interest.

We know that the Fed says we are close to the natural rate of interest, but Fed speech-making indicates a push past that natural or neutral rate, into tightening. We are not there, so don’t worry, as Professor Duy posits. And Dr. Sumner is also saying the same thing, that raising rates is not yet a tightening.