I carefully read articles about the Fed's minutes and extended forecasts. They forecast 2008 growth as 1.8 to 2.5% real growth, while expecting headline inflation to be 1.8 to 2.1% and core inflation as 1.7 to 1.9%. Unemployment is forecast as 4.8 to 4.9%. The current overnight Fed funds rate is 4.5%, which is 2.7% over the midpoint of the core inflation forecast for 2008. In Note A below from a variety of data I educe the range of reasonable "neutral" real interest rates as 1.5 to 2.5% with 2% as the central neutral level.
The inflation forecasts of the Fed itself show they have won the war on inflation: price levels are forecasted in the zone of stability - the "Comfort Zone".
The core PCE is now 1.8% year over year and the Fed midpoint forecast for 2008 is the same. So the "neutral" Fed funds rate is 3.8%. But why should the level be at "neutral" ? The Fed's own forecast shows subpar growth for 2008 and higher unemployment. So they are violating their mandate to maximize employment with stable prices. The Fed should be maintaining either below neutral real interest rates or at least a real rate at the low end of neutral, viz. either at 3.3% or lower.
Mirabile Dictu !!! Ms. Market concurs !!! The two year Treasury note is trading at 3.06% !!!
So why can't the FOMC figure this out ? Surely Ben Bernanke is as smart as his college classmate, Bunkerman. Maybe the FOMC members are still fighting the last war - inflation - and still shooting though they admit they've won. Some Fed big mouths do say that. Or it's something else. Hmmm, what could that be ? From the screeching of the press and some politicians, it's the dollar ! They are afraid the dollar will drop considerably more. Grrr, they have no statutory authority to support the dollar.
How many common men must lose their jobs & homes to support the dollar ? I'd like to hear Barney Frank ask Ben that in sworn testimony.
Let no common man be crucified on a cross of dollars ! *[see note C]
Cut rates now at least 125 bps ! Or cut 50 bps and signal continued cuts !
NOTE A - REAL INTEREST RATES
There is a range of Fed interest rate levels due to error and inaccuracy in knowledge. So accepting the core PCE inflation level of 1.8% [which corresponds to the recently released Fed "central tendency"], what range of real returns should be put onto that for overnight money ?
I remember learning in B-school that a 0% real return for T-bills was the empirically mean over long periods of time. Adding 1% for a bank risk makes sense. And I know that current Treasury inflation indexed notes give around 2-2.25% for multi-year money. And I know that old gold notes have long term rates of around 2-3%. So suppose a reasonable range is 1-3%, midpoint 2%. Let's take the range and divide by two to get a core centroid: (3% - 1%)/2 = 1% core centroid which is + or - 0.5% on the midpoint, viz. 2% real rate plus or minus 0.5%.
So higher math gives a neutral real interest rates as between 2% + or - .5%, viz. from 1.5% to 2.5%, midpoint 2% for overnight bank lending.
NOTE B - $10 words
For definitions of educe, adduce and conduce, see blog post "The 'duces" for November 19.
NOTE C -
Reminiscing the famous "Cross of Gold" speech of the "Great Commoner", William Jennings Bryan, whose only vice was an inordinate fondness for a third plateful of food :-)) [I think that's a quip from H. L. Mencken - I saw saw it a few years ago & saved it.]
"Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests, and the toilers everywhere, we will answer their demand for a gold standard by saying to them: You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold."
Source: William J. Bryan, _The First Battle: A Story of the Campaign of 1896_ (Chicago: 1897), 199-206.