July 5, 2019

IT'S A DEFLATIONARY EPOCH:

Interest Rates Just Keep Falling. Economic Orthodoxy Is Falling With Them.: Investors expect even lower growth and inflation; this isn't the way it's supposed to work. (Neil Irwin, July 4, 2019, NY Times)

Consider some of the assumptions that are embedded in the economic models of the two government agencies most respected for their independence and technical expertise: the Congressional Budget Office and the Federal Reserve.

When the C.B.O. projects how legislation will affect the economy, it assumes that when the government borrows more, higher deficits will cause interest rates to rise, crowding out investment by the private sector.

Generations of college economics students have been taught that this is simply how things work, and the reason that countries should avoid running large budget deficits. But the logic just isn't holding up right now.

For example, in the spring of 2018, when the C.B.O. modeled tax cuts and spending increases that had been agreed to the preceding winter, it forecast that higher deficits would result in higher interest rates: 3.7 percent on 10-year Treasury bonds in 2019.

That is 1.75 percentage points higher than actually was the case on Wednesday. [...]

At the meeting in December 2015 where Fed officials first raised rates, for example, their consensus projection was that the longer-term level of the unemployment rate was 4.9 percent and that they would need to raise interest rates to 3.5 percent by now to keep the economy in balance and forestall inflation.

The actual results have undermined those assumptions. The unemployment rate has fallen to 3.6 percent. But the inflation rate has remained persistently below the 2 percent the Fed aims for. If anything, the growth rate of workers' wages has been slowing in recent months. That's important because higher wage growth is, in the traditional theory, the mechanism by which a tight labor market fuels overall inflation.

Moreover, the movements in bond markets the last few weeks suggest that very low inflation is likely to be the norm indefinitely, despite the low jobless rate. 

In a global economy of free trade and technology adoption what do prices have to do with antiquated things like jobs?

Posted by at July 5, 2019 3:57 AM

  

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