Let me start with a rounded version of the Rudebusch version of the Taylor rule:It's amazing how useful simple linear macro approximations can be.
Fed funds target = 2 + 1.5 x inflation - 2 x excess unemployment
where inflation is...currently 1.6...and excess unemployment is the different between the...NAIRU (currently 4.8) and the actual unemployment rate (currently 9.8).
Right now, this rule says that the Fed funds rate should be -5.6%. So we’re hard up against the zero bound.
Suppose that core inflation stays at 1.6%....Then we can back out the unemployment rate at which the target would cross zero, suggesting that tightening should begin: it’s an excess unemployment rate of 2.2, implying an actual rate of 7 percent....
What would it take to get to that range of unemployment? Okun’s Law suggests that it takes 2 points of GDP growth in excess of potential to reduce unemployment by 1 point. Potential growth is probably around 2.5. So say we have 5 percent growth for the next 2 years — which would be hailed as a stunning boom. Even so, unemployment should fall only 2.5 points, to 7.3. In other words, even with a really strong recovery (which almost nobody expects), the Fed should keep rates on hold for at least two years.Bear in mind that I’m using entirely standard, conventional analysis here. It’s the people saying that the Fed should start tightening in the near future who are inventing some kind of new, unspecified framework to justify their views.
Monday, October 12, 2009
Krugman: Fed should not raise rates
Excellent post over at Paul Krugman's blog about why the Fed shouldn't raise rates anytime soon, despite concerns about inflation