June 17, 2017


Why I Dissented Again (Neel Kashkari, President @MinneapolisFed, , 6/17/17, Medium)

For me, deciding whether to raise rates or hold steady came down to a tension between faith and data.

On one hand, intuitively, I am inclined to believe in the logic of the Phillips curve: A tight labor market should lead to competition for workers, which should lead to higher wages. Eventually, firms will have to pass some of those costs on to their customers, which should lead to higher inflation. That makes intuitive sense. That's the faith part.

On the other hand, unfortunately, the data aren't supporting this story, with the FOMC coming up short on its inflation target for many years in a row, and now with core inflation actually falling even as the labor market is tightening. If we base our outlook for inflation on these actual data, we shouldn't have raised rates this week. Instead, we should have waited to see if the recent drop in inflation is transitory to ensure that we are fulfilling our inflation mandate.
When I'm torn between faith and data, I look at decisions from a risk management perspective.

The risk of raising rates too soon is a continuation of the FOMC's track record of coming up short of our inflation objective. As this Atlanta Fed survey┬▓ recently indicated, many people already believe that our 2 percent inflation goal is a ceiling rather than a symmetric target. Raising rates will just further strengthen that belief. And if inflation expectations drop, as we've seen in some other countries (and there are signs it might be happening here in the United States), it can be very challenging to bring them back up.

The risk of not moving soon enough generally doesn't appear to be large. If inflation does start to climb, that will actually be welcome. We will move toward our target, and I believe the FOMC will respond appropriately. And if it leads to a moderate overshoot of 2 percent, that shouldn't be concerning since we say we have a symmetric target and not a ceiling.

The Phillips Curve was propounded in 1958, before women and blacks joined the mainstream labor force in substantial numbers.  Here is the labor force participation rate since then:

You'd be hard-pressed to find any association between inflation and employment over the years since Reagan, Thatcher and Volcker broke inflation.

On the other hand, at the time Phillips was writing the percentage of the labor force in unionized jobs was at its peak. And a significant portion of breaking inflation was the action the Gipper and Iron Lady took against unions. 

The potential exists that inflation is not so much a monetary phenomenon as a function of wage demands and disempowering labor has quashed said demands, or at least the power to have them met.   

Posted by at June 17, 2017 11:41 AM