If It Ain't Broke, Don't Fix It

The bottom line is that there is substantial slack in the US economy and in particular the labor market. It is partly structural and one could argue that inflation at important levels brings people living on fixed income back in the labor force, as a couple of years with out of range inflation brings the price level up to where more people need to supplement with wages to make it to the end of the month. There is, hence, a p* (for participation) that I estimate at 64.9%. We are better served looking at this p* only as incorporated in u* for policy purposes, but it is the telltale variable that explains current conundrums. I tend to think that Fed policy is formulated looking at the broader measure, but communication is facilitated with a commonly reported direct count of the unemployed. Powell mentions U6 from time to time, which is "similar" to the broader, participation adjusted measure. The labor market has been in a long term normal range since Q4 2021, while inflation is still abnormal on a quarterly basis. PCE-PI Core inflation will likely come into its long term normal range next quarter, and the major changes to policy rates occur when you move from an out of control situation to a business as usual trajectory. Cut.

The Stars discussion is made complex by the assumptions of economic theory, but from a policy management perspective you need to cut through the fog and at least recognize tradeoff conditions, your targets, and what your r policy stance should be, given the u and pi of today and your targets. r* bottomed in Q2 2023 at 0.5%, but is now increasing and for the coming year it stays at 0.6%. Let us assume that I have the values right, and so pi* (inflation) is at 2.0%. This is likely one of the variables that would have a consensus. The u* is more difficult, as narrow unemployment - the 3.7% that you mention, means little if we do not consider labor force participation. I adjust for that and the u* is 5.6%. Q4 2023 is averaging 7%. We are not even near being at Full Employment, except in the world of Politics where Elections are 11 months away. Full Employment on a participation adjusted basis is reached at 2.2%. If you think it is 3.9% Full Employment and we currently run at 3.7% on the narrow measure, you keep making policy mistakes or analytical mistakes all the time. The reason why we can have falling inflation at "Full Employment" is that you look at the wrong measure of (un)employment. Miracles always relate to measurements.

I take issue with your comment on the neutral Fed funds rate, r*. This part of the discussion was relatively lucid when Lael Brainard was at the Fed and now it is just bandied about without context, as the navigation by the three stars, u*, r*, and pi* has been discredited, as economists have difficulty agreeing on their values, and also coming up with changing values over time. The only constant is change, and the idea of any contant constants is the only one discredited. The idea of an equilibrium condition existing in an economy is fairly wild, when you consider the concept of a business cycle, but all of economics document the tradeoffs in the course of a business cycle. Conceptually, it is not a defendable proposition that the 2.0% inflation target is reached at Full Employment. It is on average reached over a generation - 30 years, if we use the Median value. This means it is more likely that the inflation target is associated with a long term combination of median unemployment. This again means that the theory of r* being related to a Nirvana condition has no legs. In fact, r* of 0.5% is a generational moving average as well. You cannot get to 0.5% r* looking at periods of Full Employment.

I am with you on the puzzle as to why the FOMC lowered their Real GDP forecast. I usually go looking for reasons that my outlook is wrong, given that the seemingly useless bunch of FOMC directors are just fronting the work of 300 PhDs in Economics. When economies go into recession, the collapse is instant. I am watching business inventories to sales for signs of overproduction. FedEx, Nike warnings are adding to telco equipment and utilities issues from earlier. When does it become critical mass? You mention the good news of the PCE, but skipping the growth issue: the PCE miss. People are saving more of their income, which, if you are an American, means you are scared, or just paying past due credit card bills. I think it is the latter for now. So, the PCE report indicated slower PCE growth - 0.6% q-o-q annualized is very low.

Great insight