As I have stated repeatedly, I do not buy this "One and Done" meme. This is the 3rd attempt at it — the first being last June, when Dallas Fed Chair Fisher issued his now infamous 8th inning comments. Then in January, the moonshot was once again launched on that idea.
The most recent rally started last week ont he Medley advisors claim that it was One and Done (although that was subsequently revised to "maybe 1 or 2").
I find all these Fed Kremlinologists at to be junk analysis at best. My preference is for data and quantitative analysis.
With that in mind, I went to the St. Louis Fed site and downloaded all their Federal Funds Rate data. Here’s a graphic depiction of what the median monthly historical rates look like:
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This chart suggest that in order for Fed Funds to revert to the mean, the Federal Reserve Board has a ways to go — both in rates and in time.
Note that we are now at 4.5%. Even if the Fed were to stand pat at 4.5%, the passage of time will move the 2000 – 2006 monthly median closer to the prior market periods median — each passing month raises the median.
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UPDATE: March 21, 2006 5:07pm
CB raises the question — correctly — that equating average funds rate is not sound given the difference in inflation; Low now, 10% then.
My response is that I believe inflation is much higher than the present CPI reflects; The key change in CPI construction was the owners equivalent rent, which we addressed repeatedly here. Without the 1983 owners equivalent rent adjustment, the CPI would be
more like 5.3% — not the 10+% of the 1970s, but certainly not the 1-2%
its claimed to be at present.
Given the significance of housing to this economy — and with Housing Affordability Index at 14 year lows — its kinda silly to take CPI data seriously as a true measure of inflation.
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UPDATE 2: March 22, 2006 6:07am
Rex Nutting makes an even better suggestion: Apply the same analysis using real versus nominal Fed rates.
I’m not a huge fan of Boskin, PCE, or even the CPI for that matter — I do not think they reflect inflation reality as experienced int he real world. But controlling for Real Fed Fund Rates (as opposed to nominal) may be more revealing than not controlling for inflation
The St.L Fed is such a pleasure to work with — they give you all the data formatted in Excel already! Its intriguing — let me see if I can find the Real Fed data in Excel (or pull it off of Bloomberg).
Barry-
The underweighting of the health care component is also a serious flaw. But there are so many flaws it’s difficult to keeep track!
Health care, saving for college, saving for retirement and
energy costs have made having a family very expensive
for me. And I’m on a modest six-figure salary.
I guess the McMansion didn’t help either.
I should’ve stayed a single bachelor like Kudlow & Ritholtz.
As a previous poster mentioned, they’re both notorious swingers.
-Barry 2.0
Aw, c’mon guys, this is all pretty simple. Think about what would happen to entitlement payments if the Fed really used the real inflation. Of course, the Fed is above politics, oops, almost hurt myself typing that one.
Sorry but you are being to simplistic. Total household debt is much higher today than in the past. Much lower rates will suffice in cooling off the economy by reducing household spending power.
As for how much less, that is for the fed to decide. But simplisticly comparing rates over decades when household debt levels varries dramaticlly is simply wrong.
inflation:
46-66: 2.1%
66-82: 7.0%
82-00: 3.3%
No matter the inflation, Fed funds averaged close to 6%. Following this logic, the only case we can make is that Fed funds should always revert to 6%.
Things to keep in mind:
a) One’s own views of the inflationary reality is irrelevant to Fed decision making. Our hosts views regarding official inflation measures is not going to matter at all in determining the end of rate hikes.
b) Historic norms are important to keep in mind, but Fed officials spend lots of time and energy telling us about things that go into monetary policy thinking. Many of the things they tell us have to do with structural and environmental changes. Relying on reversion to the mean, or median, or whatever, ignores the changes about which Fed officials have made so much noise. Faster productivity gains, contained inflation expectations and the like. Once again, one’s own views about these things should not be confused with anything that actually matters. It is policy makers views that determine policy.
c) In considering whether to look at nominal or real rates, using long averages for inflation and nominal Fed funds rates doesn’t help. The 1962-1982 period included an extreme range of inflation performance. The best approach is probably to construct (or find) a series for real Fed funds, and use that instead, as our host suggests.
FRED has CPI data. If you take the monthly fed funds rate and subtract the trailing 12-month CPI (NSA), you get the real fed funds rate. It yields and interestnig chart. How does one post a spreadsheet or chart to a comment here?
Since when are interest rates mean reverting??
trends on real rates.
http://economistsview.typepad.com/economistsview/2005/12/the_expost_real.html
The Fed just wants to keep a level uncertainty alive in the process, with good reason; economic systems can behave like hourglass sand. They continue to accumulate until some event disturbs the buildup, allowing it to dissipate energy and fall to a more stable configuration at lower energy.
The Fed is just shaking the heap to create a number of small corrections rather than risking a single cataclysmic response.
Another point of interest; there are certain disease states that exhibit very steady heart rhythms; unfortunately, such overly regular heart rhythms tend to be brittle since they don’t respond well to environmental stimulii that challenge this stasis.
I agree with this “pattern prediction”, to cue off Popper. The “this time it’s different” mantra shatters each time. The simple view is that cycles remain. That inflationary forces remain. Sometimes the magnitudes may differ, but as the above analysis suggests, the magnitudes have not been that different.
I agree with this “pattern prediction”, to cue off Popper. The “this time it’s different” mantra shatters each time. The simple view is that cycles remain. That inflationary forces remain. Sometimes the magnitudes may differ, but as the above analysis suggests, the magnitudes have not been that different.
Real Fed Fund Rates
Last week, we looked at the historical range of Federal Reserve Funds since 1946. It was a simple mean reversion, and did not incorporate the post WWII price controls, the 1970s inflation spike, or the Bretton Woods agreement. As such, some implied tha…