Monetary policy: How unusual is Fed policy?

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UNEMPLOYMENT dropped to 6.1% in today's non-farm payroll numbers, the lowest level for six years. The recent data have been a little bewildering to put it mildly; first quarter GDP showed an annualised 2.9% decline. It is very rare for the US economy to have an isolated one quarter drop, except in the aftermath of a recession; the last occasion was 1973 (some would count Q1 2011 but that seemed like the tail end of the last recession).

Still the markets are treating the data as if the US economy is rebounding strongly. If that is the case, then are low Fed rates appropriate? Back in September 2008, when unemployment was last at this level, the Fed funds rate was 2% (and on its way down). Mind you, inflation was a lot higher at 4.9% (albeit, about to fall very sharply). A better comparison would be September 2003, when unemployment was 6.1% and inflation 2%; then the Fed funds rate was just 1%. Of course, that rate looks way too low in the light of subsequent events., and may well have stoked the housing bubble.

How does policy look over the longer term? The misery index, which adds inflation to unemployment, isn't the right comparison. Instead, I deducted unemployment from inflation. If inflation is high and unemployment low, one would expect rates to be high; if inflation is low and unemployment high, rates should be low. As you can see there is a rough relationship (note the different scales; unemployment is normally higher so the balance is normally negative). But while the gap between inflation and unemployment is narrowing, the Fed funds rate is unchanged. This is not an argument for pushing rates higher immediately but it does indicate that Fed policy looks more unusual (in the sense of being inconsistent with history) than it did before.

The 2.9% was mostly due to health care. Super inflation in health care slowed, so there was less service inflation to mischaracterize as GDP.

The economy has actually been going backward for some time. Less oil is being utilized, and the labor force participation rate is going backward. However, 10% service price inflation minus 2% CPI was booked as 8% GDP improvement. No additional products were produced in this transaction, but the resultant GDP numbers seemed good.

More tellingly though, is that GDP does not separate useful production from Keynesian pyramids. Thus the construction of empty McMansions was booked as GDP, even though it led to the 08 credit situation.

Unless GDP stats are made sensible, they will not be useful for bank central planning of the economy. The art of economic central planning needs additional research before it can allocate capital efficiently. Until then, the bank will keep on centrally planning bubbles, empty McMansions, and other silliness.