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Fiscal Support, Mester, Evans

A few items of note from today:

First, a contact sent me this quote from Jan Hatzius of Goldman Sachs:

Although we strongly agree with the macroeconomic case for additional fiscal support because the level of employment remains far below potential, we are not particularly concerned about an outright stall in the recovery even if this support doesn’t materialize.

I don’t have the rest of the report. As far as this part of the analysis is concerned, I agree. Most likely, net job growth will continue even if at a slower pace. That job growth will be sufficient to drive income growth, and income growth will support consumption. But what about the missing fiscal stimulus, you say? I know this will be widely hated, but the decline in spending in nominal and real terms at this point pretty much matches the decline in income excluding current transfer payments:

The fall in consumption exceeded the fall in incomes early in the cycle while, on net, transfer payments are ending up as forced saving. The virus is the key impediment to growth at this point; there are certain sectors of the economy, leisure and hospitality in particular, with limited prospects until the virus is under greater control. There isn’t really a debate on this point; there is simply a nontrivial supply-side constraint on the economy right now.

Next, via ForexLive, Cleveland Federal Reserve President Loretta Mester is reported to have voiced support for changing the composition of asset purchases to push buying out toward the longer end of the yield curve. This is interesting as it comes at the same time that the longest end of the curve is hitting a bit of a milestone:

It’s just sad what we get excited about these days, isn’t it? I am not confident conditions will change sufficiently anytime soon to create a substantial steepening of the yield curve (Cornerstone Macro had a nice note on that topic this morning) and Mester’s comment is a reminder that the Fed might choose to get in the way of any potential steepening as well.

Or will they? Buried in Chicago Federal Reserve President Charles Evans’ speech today is this line:

These challenges will be compounded by the fact that short-run r* today likely is depressed below its long-run value, but should move up to long-run r* as the economy recovers.  Describing the stance of policy against a moving and unobservable benchmark is another complicated communications challenge.

Evans at this point was discussing the litany of communications challenges surrounding the eventual (hah hah) lift off from the zero bound in the context of the Fed’s new strategy. One point he made is that even after lift-off policy will still be accommodative because r* will be rising back toward its long-run level. Which is a reminder that the Fed could just to view upward pressure on the long end of the yield curve as a signal that the economy is healing and just let it happen.

In any event, it is always good to remember that the Fed has in its back pocket an estimate of short run r*; the r* gleaned from the Summary of Economic projections is the long run version.

Evans presents this hypothetical application of the Fed’s new strategy:

Forget the many years of underrunning 2 percent since 2008, and let’s just start averaging beginning with the price level in the first quarter of 2020. Core PCE inflation in the SEP is projected to be 1-1/12 percent this year and then gradually rise to 2 percent in 2023. Suppose it hits 2-1/4 percent in 2024 and then stays there. In this scenario, cumulative average core inflation starting from the first quarter of 2020 does not reach 2 percent until mid-2026. That is a long time. If you can produce 2-1/2 percent inflation in 2024, you can get there about a year quicker. Some, though, might view 2-1/2 percent inflation as an excessive overshoot. And don’t forget, that is under a positive economic outlook such as in the SEP, which in my submission depends on strong fiscal and public health support.

That’s the kind of story bound to raise questions about why the Fed isn’t doing more now.

If you want more background on r*, listen to this Bloomberg Odd Lots podcast with IMF economist Peter Williams.

That’s it for tonight. Good luck tomorrow and stay safe.