Pondering a Pause

Econobloggers across the land are betwixt and between, wondering what their fearless leader will do one week from today when he next convenes the venerable Board of Governors of the Federal Reserve. Right now it looks like a pause.

But, inflation is not contained!

Slowing growth will tame the inflation monster.

But, how can we be sure?

The inflation is not a result of rising wages, don't worry.

But have we tightened enough?

We'll know in six to nine months.

Have we tightened too much?

We'll know in six to nine months.

What if we can't wait six to nine months?

Uh ...

As always, with another FOMC meeting approaching, economists with blogs are pondering the possibility of a pause, attempting to read the minds of the members of the Federal Reserve as the hours tick down to the next monetary policy announcement - as this goes to print, only 172 hours to go.

Absent statistics on the subject to enable a clear determination, it sure feels like this is the closest we've been to an upcoming Fed meeting where the outcome had not already been known. Not in recent memory, it seems, was there such uncertainty with just a week to go.

According to David Altig at Macroblog, there's a little less certainty now than just a few days ago. With a timely update to his Fed funds futures probabilities, it appears that Friday's weak GDP number has trumped the 2.9 percent annualized change to core PCE - now a pause is preferred by a margin of about 68 to 30.
Not once in the last four weeks has either outcome breached the 60 percent probability mark. It seems a clear trend has developed in recent days, however, this morning's personal income and outlays report was on the strong side, so maybe it's not a done deal quite yet.

James Hamilton at EconBrowser says, "that's it", confirming the swing toward a kinder, gentler Fed - one that will not deliver any more medicine next Tuesday. Not that the patient doesn't need more medicine, mind you, but for fear that an additional dose right now just might cause seizures or some other unwelcome side effect.

Speaking of unwelcome side effects, James noted comments back in June by Fed chair Ben Bernanke regarding the unwelcome lagging effects of the monetary policy implemented by his predecessor:

While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth. For example, at annual rates, core inflation as measured by the consumer price index excluding food and energy prices was 3.2 percent over the past three months and 2.8 percent over the past six months. For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent. These are unwelcome developments.

In an attempt to square these remarks with the latest price statistics, James continues:

So what's changed? Not good news about inflation, surely
...
There is basically no way to slice the inflation data since then to come up with numbers that are any lower than these "unwelcome" numerical guidelines that Bernanke identified. The data arguing for a pause come instead from the real side. In particular, the new home sales figures released Thursday paint a pretty clear picture that the housing slowdown we'd all worried about is now well underway. Falling residential construction made a negative contribution to second quarter GDP and has more downside potential.
...
The risks for real output of another immediate rate hike are all too obvious. What about the risks to inflationary expectations if there is a pause? The response in markets such as gold and the dollar was pretty dramatic the last time the pause balloon was floated.

Meanwhile, Mark Thoma at Economist's View opines:

What should the Fed do? I think the Fed should pause at its meeting next week, let past tightening catch up, and reassess the situation at September's meeting. That will reduce the chances of overshooting.

Naturally, Nouriel Roubini at RGE Monitor, takes a rather dim view of the whole affair, explaining that there is little nothing that can be done at this point to avoid a recession.

It is now clear that the Fed is in panic mode about the risks of a U.S. recession; they hoped to get a soft landing but, obviously, the Three Ugly Bears that I have been warning about since last fall - high oil prices, a slumping housing and rising inflation leading to higher short and long term interest rates - are now killing the economy.
...
The Fed will not be able to avoid the coming recession even if it were to pause now and ease in the fall.
...
There will no so soft landing and the recession will be painful. And the Fed will be able to do little to prevent the coming recession. The recession train wreck is having too much of its own unstoppable momentum now – as it did in 1974, 1980, 1990, and 2000 – for the Fed to be able to stop it. Fed pause or easing will not avert the coming recession. We will now pay for living above our means for too long, for making serious fiscal and monetary policy mistakes that allowed only a drugged recovery, and for creating unsustainable macroeconomic and financial imbalances that festered for too long. Thus, the coming payback will be unavoidable - whatever the Fed does or does not - and most painful for the U.S. and for the global economy.

Oh my! That sounds awful - 1974, 1980, 1990, 2000 and now 2006 or 2007?

According to Nouriel, a recession in the States is unavoidable - for the sake of us Americans, billions of Asians, and much of the rest of the world, let's hope it's not too bad.

Whatever the timing or degree of the economic slowdown, one thing seems clear - the job of the making monetary policy in the years ahead will not be an easy one.

In response to a crashing stock market at the turn of the century, good 'ol Alan Greenspan just yelled "DEFLATION" at the top of his lungs and let rates drop like a rock, kicking off the biggest housing boom and carry trade the world has ever seen. Cheap imports, cheap energy, and declining rents all suppressed the consumer price index, making the deflation story a compelling one for those who looked only at the headline inflation numbers.

In another era, Ben Bernanke might take the same approach, however, energy and rents are working against him at the moment. How will he pump up the economy without the cover of a "deflation" scare?

Put real housing prices back into the price indexes? That's an excellent idea.

But, more importantly, what happens when the pumping begins? What asset class gets inflated to grotesque proportions next time around?

One look at the chart below and it's clear that the last time, back in 2000 to 2002, there was a neat hand-off between stocks and real estate - real estate assets soared as stock prices fell. What will soar next if home prices fall?




Where's the next bubble going to be?

That's the more important question - not whether or not there will be a pause.