The Fed Mistakes: Why Productivity Is Declining

Next week the Fed will make a decision on whether to hike rates or keep them steady. Since the last time I wrote about this topic, the chance of a rate hike has fallen from 100% to 92.7%. The idea that the chance of a rate hike is 100% was over the top given the Fed has not explicitly guaranteed a hike. This lowering of chances has brought them to a more rational amount. I still expect a rate hike in December after we’ve seen some moderate pickups in data and heard some hawkish language from the Fed. Objectively, the economy has been stronger at other parts in this recovery, so when I say the Fed will raise rates in December, I’m not defending it as consistent, rational decision making.

The Fed now has to deal with President Trump’s economic policies when answering questions, making forward guidance, and making decisions on rates and the size of its balance sheet. Not surprisingly, the Fed has made mistakes in the recent statements it has made regarding Trump’s potential policies. I will go over them in this post.

The Fed has warned Trump against doing explicit stimulus because the economy is not in a recession and the employment picture is strong. I’m not a fan of stimulus either, but not for the same reasons as the Fed. Fiscal spending has a negative multiplier effect as the short-term growth created by spending is outweighed by the drag the debt increases have on the economy. Per Lacy Hunt, the government spending GDP multiplier is -0.01. It’s an obvious conclusion to make given the economy has taken on more debt over the past few decades, only to have slowing GDP growth per capita.

However, the Fed is not against Trump doing deficit spending because it hurts the economy. It thinks it helps the economy too much which will cause it to overheat which will cause inflation to rise and the Fed to have to raise rates. While I agree with the Fed, that the economy is not currently in a recession, the idea that the economy is close to growing too fast is wrong. The annual GDP growth rate as of October is 1.6%. I also question the narrative that economic growth being too strong causes inflation. It depends on what kind of growth we have. If we have true economic growth caused by increases in production, then prices will fall. If we have growth in spending caused by the middle class taking on more debt, we will see inflation. Trump should try to spur economic growth because this recovery has been weak; he shouldn’t worry about growing the economy too fast. He should focus on creating an environment where we can have true capitalism, so real growth can occur.