A James Alexander post

Watching the recording of NY Fed Dudley’s market-moving live interview with the WSJ yesterday morning reminded me of a man caught in a trap.

When his interviewer, Jon Hilsenrath, rather melodramatically paused the interview after Dudley, a well-known dove, repeated the mantra about a likely rate rise before the end of 2015 the NY Fed chief looked quite alarmed.

The weirdest thing he said was that the US was “growing above trend”. If he really believes that it would be good to see some evidence. He didn’t bring up above trend growth in his June 2015 interview with the FT. So it is a new concern that he thinks growth is above trend now. Perhaps he was just thinking of the  upwardly revised 3.7% annualised growth 2q15/1q15 versus the (also upwardly revised) 0.6% annualised growth 1q15/4q14. If so, this seems incredibly short term and far too reliant on noisy qoq annualised growth rates – and certainly ignores falling NGDP growth.

Clearly, he was uncomfortable having to toe the line of his boss, Janet Yellen, who seems keenest on a 2015 rate increase. It didn’t look like he really believed in the rise but was simply being loyal. Admirable, but misguided. He should be his own man, but then if he was his own man he’d probably never have been appointed by the NY money-center banks to head the NY Fed.

The biggest issue was his constant refrain that he and the FOMC were “data dependent”. That they weren’t trapped by a calendar commitment to anything. But one of the data points that the FOMC talks up is financial market data. This presents a problem in the current environment of a threatened rate rise. The global economy is slowing, partly due to most of the non-US world having tied itself to US monetary policy, and the US economy is OK but not great. The markets recognise this troubling situation and so increasingly focus on the Fed’s monetary policy stance. And with the active tightening bias this causes more financial market turmoil, highlighted in real time during his interview. And so the financial data becomes worse, for a “data dependent” Fed.

The circularity of this seems to be lost on the FOMC. Dudley and the FOMC seem to think of themselves as observers half of the time rather than participants. It is a vicious circle, but one that could be broken out of if the Fed were to target  NGDP growth expectations instead – with an allowance for going over the target if there is some undershooting of the target in practice.

Obviously, the circle may not be quite so swiftly vicious if the FOMC really do keep to their data dependency, as financial markets will not let them actively tighten. That said, the slow strangulation will continue, and if the rest of the world has a crisis that does then infect US demand, then the FOMC will have to re-start QE or move to negative interest rates, things they seem really loathe to do – in the absence of altering the target of monetary policy to a much better monetary aggregate like NGDP.