A ‘Gross Misinterpretation’ Of Milton Friedman
Over and over again in 2022, economists, analysts, policymakers and market observers engaged in the "long and variable lags" debate.
The Fed's aggressive rate hikes will manifest in slower growth and, hopefully, slower inflation, but on an unpredictable delay. It's impossible to say, with anything approaching certainty, how long that delay is. It's also quite difficult to preemptively quantify the growth drag and/or the disinflationary impulse.
This is especially problematic in the current con
Home prices are too high. Rents are too high. Food prices are too high. Drug prices are too high. The cost of health insurance is too high. Tutition is too high. The U.S. economy needs a dose of deflation. And with the labor market as strong as it is, now is the time to let some air out of the Bubble.
I have been keeping an eye on the velocity M2, historically low. From my education in the 70s it was one of the things to keep an eye on about inflation. It is also why I have not gotten too worried about this inflationary occurrence. Pandemic labor shortages, and a hot war in Europe. Bassman and some of the other writers you’ve referred to seem to resonate with me.
Heavy cash and see what it looks like in March.
“Heavy cash and see what it looks like in March.” That sounds about right. I put new income to work when the opportunity arose — bought six new insured, call protected 5% AA munis. Rates on these same kinds of issues have recently dropped to 4.25% so now we wait. I haven’t sold anything to raise cash but I’m now letting my income pile up. Should be a nice pile in March or April.
Just on the Goldman Financial Conditions index, looking at a historical time series suggests that cycle peaks (i.e. peak ‘tightening’) tended to occur when the Fed was actually cutting rates or policy rate expectations were falling (i.e. during recessions and major growth downturns). This suggests that the credit cycle has a much bigger impact on such indices than the policy rate cycle (to the degree they have a bigger impact on credit spreads and risk asset valuations, implying that during a true recession the Fed, at least initially, cannot cut rates fast enough to drive an easing in the FCI). Makes you wonder if such indices are leading indicators to the real economy or are driven by them.
Back to Friedman, I do think we spend too much time talking about the “price” of money and not enough about the “quantity” given it’s the latter that matters far more for the real economy. Perhaps it’s because defining the money supply or quantifying it is so difficult in 2022 that we take the shortcut of using interest rates as defining whether monetary conditions or ‘tight’ or ‘loose’ (Friedman would refer us to the “interest rate fallacy” most likely).
If I correctly understand GS’ charts and this post, the FCI tightening delivered to date may produce peak deceleration of PCE inflation in mid 2023 with the remaining deceleration during 2H23, while peak deceleration in GDP growth is occurring right about now and the remaining deceleration is to come in 1H23.
This seems inconsistent with investors’ apparent belief that the deceleration in GDP growth will compel the Fed to start cutting rates sometime in 2023. If we’ve already seen half of the hit to GDP, the full hit won’t be big enough to pressure the Fed to start easing before reaping the full inflation impact of its labors.
In other words, “higher for longer”.
In other other words, what the FOMC is saying it will do might indeed be what it does.