Inflation is not a reason to normalize nominal rates… Lower potential output is
There is a concern that many economists want the Federal Reserve to tighten monetary policy because the inflation monster is lurking out there. Maybe tighten is not the best word to use. “Normalize” monetary policy is a better term. Well anyway, the inflation monster is not lurking while labor share rises so slowly.
Then, is there a reason to normalize monetary policy? Yes… Lower potential output.
We read in some blogs today that inequality lowers growth potential. But now the logical conclusion is that potential output really must be lower than the CBO projects. In which case, we are much closer to the end of the business cycle than many think. And the Federal Reserve would not like to have a zero lower bound nominal interest rate as the business cycle tops out. They would prefer some traction if the economy started to sputter.
Can you imagine how embarrassing it would be for the Federal Reserve to have an effective zero lower bound nominal rate if a recession started? There would be incredible soul-searching.
Well, the Fed has dug themselves into a slippery mud hole with little traction to get out. The end of the business cycle is closer than they think if one sees lower growth potential due to highly increased inequality AFTER the crisis. And they will not be able to raise nominal rates fast enough, especially if they plan to raise nominal rates by 25 basis points per quarter. So if the business cycle tops out mid-2015, they might have a 0.50% effective Fed rate. This rate is effectively a zero lower bound rate.
But really, it is too late for monetary policy to normalize now. There is not enough time. The planned rise in nominal rates is too slow, and raising them faster would be too much for the markets to handle.
The economy seems to be sputtering already. That -2.1% GDP growth in the 1st quarter being a prime indicator. The auto companies are resorting to leases to move inventory. And the news from Europe just seems to get worse and worse.
So it does not seem likely that the FED would increase interest rates in that environment.
Looking at the problem from a different angle. If they raise interest rates, they might well bring on the next recession immediately.
Just ask yourself how businesses would react if they thought the FED was going to repeat 1937. It seems to me that they would be much more concerned about existing excess inventory or of creating more. They would reduce inventories by reducing production.
Therefore I agree with you that it is too late for the FED.
The gains in productivity and manufacturing seem to indicate that there is still room to grow, and falling gas prices should further reduce costs for the rest of the year, meaning the cycle hasn’t yet peaked.
The key still remains employment growth (which the low jobless claims give hope for), as well as wage gains and consumer spending.
I do not see the gains in productivity…
Productivity is still where it was at the end of 2010.
And falling gas prices could be a sign of falling demand for petroleum similar to what is happening with the price of copper.
You are describing Say’s law that more employment will create greater income and greater consumer spending and thus greater production in an ever spiraling upward direction. Do you not realize there is a natural limit upon Say’s law called effective demand?
So many seem to think that increased employment will simply break through effective demand. The fault is not understanding what happens to profit rates in that process. Profit rates will shut down Say’s law.
Everything you mention is still happening within and against the effective demand limit. There still seems to be great hope for greater and greater growth back to the previous full employment… but it will seem that way right up until the end… an end which is closer than many think… and end which is below full employment.
A new branch of Keynesianism is about to appear with an understanding of effective demand… finally.
I disagree that I am describing Say ‘ s law Ed
If I understand correctly, Say believed that Demand followed Supply.
That increasing Supply of something would result in increased demand. That there was no such thing as under consumption, just cases of supply and demand mismatches and that increasing production would typically increase consumption.
However this is false, as there are clear cases of under consumption, and there is clearly no huge mismatch between supply and demand holding back the economy.
In fact it’s demand that leads supply. Increasing production will not result in higher consumption if demand is satiated or if it’s falling (such as when people and buisnesses are seeing their wealth decline such as during a market crash and pull back their consumption)
If demand is satiated, or if it’s falling, then increasing supply will not result in higher consumption.
Rather it’s an increase in demand (for goods and services) that results in increased supply of said products which requires an increase in demand for labor, which increases supply of labor as more people reenter labor market, which leads to an upward cycle as more people have more disposable income. And i believe that decreased profit rates only occur if the marginal revenue is less than the marginal costs.
One comment to what you said… “And i believe that decreased profit rates only occur if the marginal revenue is less than the marginal costs.”
Remember Keynes said… “The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.”
So even though it could still be profitable to employ more workers, production is inhibited below that point. I see the inhibition coming from labor’s share being low.