Popular Economics Weekly
Graph: MarketWatch/R Shiller
“The Federal Reserve has a chance to do something no U.S. central bank has done before, if it can slow the economy and raise the unemployment rate without pushing the economy into recession,” said Peter Hooper, chief economist at Deutsche Bank Securities in a MarketWatch interview.
“The Powell Fed can make history by engineering a soft landing from below,” Hooper said in the interview.
Good luck, is my response, as no Fed has engineered a soft landing in the past. A soft landing is when US economic growth gradually slows rather than crashes at the start of a recession, as evidenced by the five recessions experienced just since 1981 in which homeowners and financial markets suffered great losses.
Fed Chairman Jerome Powell was stating his so-called “Powell Doctrine” at the annual Jackson Hole symposium of leading economists. He said the Fed should respond to actual market conditions—for instance, whether inflation is too high or too low—rather than macroeconomic formulas that attempt to predict future downturns, such as formulas economists use to determine a “neutral rate of inflation.”
He said in his speech: “I see the current path of gradually raising interest rates as the FOMC’s approach to taking seriously both of these risks. While the unemployment rate is below the Committee’s estimate of the longer-run natural rate, estimates of this rate are quite uncertain. The same is true of estimates of the neutral interest rate. We therefore refer to many indicators (my bold) when judging the degree of slack in the economy or the degree of accommodation in the current policy stance. We are also aware that, over time, inflation has become much less responsive to changes in resource utilization.”
Nobel economist Robert Shiller, who won his Nobel Prize studying individual and group behavior in financial markets, is already warning about an irrational exuberance being fed by record corporate profits which could lead to a so-called “hard landing” of the economy. Excessive profits are just one of the indicators Chairman Powell says the Fed should focus on.
Corporations have actually been reporting record profits for years—in 2014 it was the highest as a percentage of GDP, historically—and corporate profits are being further supercharged by the huge reduction in the corporate capital gains tax enacted in December 2017.
“Apparently, investors believe that this boom is going to last, or at least that other investors think it should last, which is why they are bidding up stock prices in a dramatic response to the earnings increase,” said Professor Shiller.
“The reason for this confidence is hard to pin down,” continued Shiller, “but it must be rooted in the public’s loss of healthy skepticism about corporate earnings, together with an absence of popular narratives that tie the increase in earnings to transient factors. Talk of an expanding trade war and other possible actions by a volatile U.S. president just does not seem strongly linked to talk of earnings forecasts — at least not yet.”
Irrational over-exuberance has been a problem in the past for investors, and was highlighted by then Fed Chairman Greenspan in his famous 1996 speech. He was right, but the actual downturn happened four years later with the dot-com, high tech recession of 2000.
So even with the best of information and intentions, the Fed will find it hard to predict when and if a soft landing is possible.
Harlan Green © 2018
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