Taps Coogan – June 17th, 2022

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We first made this point in 2019 and we’ll make it again today. By relying on ideologically biased models instead using common sense, the Fed has become a pro-cyclical institution, exacerbating booms and busts.

The last two years have been a caricature of that phenomenon. The Fed spent an entire year from March 2021 until March 2022 holding interest rates at zero and printing another roughly $1.5 trillion while PCE core inflation – essentially the lowest inflation measure at the Fed – ran wildly above its 2% target. During those same 12 months, real GDP spiked to as high as 12% – the highest quarterly reading since 1950, and job openings outpaced job applicants by more than two fold.

The Fed didn’t tighten policy because its institutional and ideological bias said inflation would be ‘transitory.’

Only after first quarter real GDP turned negative, consumer sentiment hit generational lows, the labor market started slowing, consumer spending started to retrench, and financial markets took a dive, did the Fed start to meaningfully hike rates and only this month does the Fed start reducing its balance sheet.

Simply put, after making the mistake of aggressively easing into a boom, the Fed is intent on proving that they can make the opposite mistake: aggressively tightening into a bust.

With regards to accelerating the pace of tightening at this point, let’s parse the logic a bit.

First quarter GDP was negative and the FedNow forecast is pointing to ‘zero’ for the second quarter. The yield curve has inverted and financial markets are pointing to a recession. The excess demand component of inflation is clearly on a trajectory to ‘correct’ aggressively based on the modest tightening that’s already been executed.

Monetary policy works with long and variable lags. Inflation statistics lag reality by at least a month. Inflation sub-components like rent lag by nearly a year. By the time the Fed realizes that it is tightening too quickly, they will have been tightening too quickly for months, the effects of which will persist regardless of subsequent policy changes in exactly the same way that their mistakes in 2020 and 2021 persist today via inflation, regardless of their current policy stance.

Here is a word of advice to the Fed. If real GDP and inflation are double or triple your target and the money supply is growing at the fastest pace on record by double, and your model still says ‘print money,’ throw out the model and part ways with anyone that took it seriously. If the model says ‘slam on the brakes even harder’ as the economy rapidly decelerates, do the same thing.

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