The Slack and Slop at the Fed

FOMC Chairman Powell answers a reporter’s question at the press conference. September 26, 2018. Photo courtesy of the Federal Reserve.

At Stockman’s Contra Corner, David Stockman explains that the Federal Reserve’s levers of control over the economy include a lot of “slack” and “slop.” Such imprecise control leaves a lot of room for mistakes. He writes:

But here’s the thing. The Fed’s only real anti-inflation tool amounts to toggling the money market interest rate (i.e. Fed funds) on the theory that this will cause aggregate demand to ebb or flow. In turn, the latter will presumably levitate the rate of inflation up or down.

In metaphorical terms, the US economy is conceived by our Keynesian central bankers as the equivalent of a giant bathtub. When the latter is full to the brim or overflowing with “aggregate demand”, inflationary pressures intensify until the Fed drains off the excess in what amounts to a Phillips Curve based blood-letting operation.

And, contrariwise, when the water-level is low, the Fed purports to “stimulate” the lethargic business and consumer slugs meandering along the bottom of the tub with a view to restoring full-employment. And it so energizes the slugs without worry about the inflationary consequences of too much money-printing because, well, the Phillips Curve again.

Alas, this is all bunkum, baloney and nonsense. The macroeconomy is driven by billions of prices for discreet units of goods, services, labor, capital, land, technology etc, not by abstract aggregates like household “consumption” or business “investment”.

The Fed’s attempts to manipulate these billowy aggregates, therefore, inherently involves a huge amount of slack and slop in the steering gear. The flows attendant to $27 trillion worth of economic activity in the US bathtub are deflected, channeled and modulated somewhat unpredictably by billions of economic factor prices and transactions; and are also subject to the machinations of other major central banks, which, in turn, are mediated though the global flow of traded goods and services, as well as capital and finance.

More specifically, the problem in terms of short-run inflation rates is that the overwhelming share of durable goods are imported, whereas most services are supplied domestically and reflect largely domestic wages and costs. Accordingly, the Fed’s aggregate demand pumping operations should presumably impact services prices heavily and imported durable goods prices far less, and in some cases (like toys which are 100% imported) hardly at all.

Read more here.