How Does Fed-Speak Match With Reality?

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Summary

The Federal Reserve continues to follow the same path as evidenced by the recent speech of Fed Vice-Chair Stanley Fischer.

The outlook presented in the speech is that things will continue to improve, both in the labor market and in terms of the rebound in inflation to the Fed's goal.

However, the Fed has been saying this for quite a few years now and their talk and their models continue to outperform the markets, same old, same old.

The latest effort to justify the current Federal Reserve policy position comes from Fed Vice-chairman Stanley Fischer.

Mr. Fischer spoke Sunday at the annual group meeting of the International Banking Seminar in Washington, D.C.

In this speech, Mr. Fischer attempted to put into perspective the September projections of the members of the Fed's Federal Open Market Committee. These projections can be found on the Federal Reserve's website.

The presentation, in my mind, was an attempt to put the best face on a not-so-good outlook, one that has been created using "legacy" economic models that have grossly underperformed over the full duration of the current seven-year period of economic recovery.

Bottom line: Fed officials expect that the economy will produce a 1.8 percent rate of real GDP growth in 2016 followed by a growth rate of 2.0 percent in 2017 and 2018.

In 2019, the initial Fed projection is for a 1.8 percent rate of growth.

Mr. Fischer doesn't really address these figures, but concentrates on the last half of 2016.

Given that the first half of 2016 was pretty dismal, real GDP grew, year over year, by 1 ¼ percent, Mr. Fischer admits the second half of the year must be quite a bit better to get the overall growth rate for the year up to 1.8 percent.

Well, we hear that the sizable inventory correction that took place during the first six months of the year has "now run its course" and, he says, "most analysts" see the second half of the year turning in a performance of 2 ¾ percent.

What seems to be accounting for the slow overall growth? It seems as if economic growth does not want to pick up.

The answer, well, slow investment growth, seemingly due to the declining activity in the energy sector, and weak productivity growth that is impacting manufacturing, and low exports due to the strength in the value of the dollar.

But, he "expects things to pick up."

Oh, speaking of the "exceptionally poor labor productivity growth," Mr. Fischer seems to have nothing to say.

Other than the "exceptionally poor labor productivity growth" the labor markets are producing statistics that are showing continued improvement. Payrolls are up, "well above what is needed to provide jobs for new entrants into the labor force."

The unemployment rate rose last month from 4.9 percent to 5.0 percent due to folks re-entering the labor market hence resulting in a rise in the labor force participation rate.

Still, something is wrong in the labor area. With the "exceptionally poor labor productivity growth" and the fact that so much of the labor force is either working part-time but wanting full-time jobs as well as the low labor force participation rates, something is going on in the labor markets that is not being picked up in the "old" way of thinking.

This could be because Federal Reserve thinking and Federal Reserve models tend to emphasize the demand side of the economy… and not the supply side.

This gets us into the realm of thinking suggested by the economist Robert Gordon in his well-received book titled, "The Rise and Fall of American Growth." Something is going on in the economy that officials at the Federal Reserve and other policy-makers are not picking up.

Yet, Mr. Fischer says that "Conditions in the labor market are strengthening, and we expect that to continue." The September projections indicate that the unemployment rate will drop to 4.5 percent in 2018.

But, conditions in the labor market are not satisfying. Surveys indicate that workers are unhappy. Real wage growth has not increased much and is not expected to remain relatively tepid. So much work is now part-time and the rise in people working in their own "gigs" is remarkable. The demands for a rise in the minimum wage level continue to grow. What will an increase in the minimum wage do to employment? The labor market, despite the numbers that are being produced, is not happy.

And, businesses continue to see the future with a very pessimistic outlook. Uncertainty reigns!

Who is going to be elected President? What will be the result of Brexit? What about the collapse of the European Union? And, so on…

What about inflation?

Mr. Fischer states, "I believe that transitory effects of the fall in oil prices and the rise in the dollar are the primary reason that inflation has fallen short of the FOMC's 2 percent goal." This period is ending and Mr. Fischer expects "inflation will likely move closer to 2 percent."

Mr. Fischer has been expecting this rebound for at least three years.

The inflationary expectations built into government bonds is now around 1.6 percent, both for the five-year horizon and for the ten-year horizon.

The Federal Reserve projections have inflation at 1.3 percent for 2016 and 1.9 percent for 2017. After that, the inflation rate is projected to be at 2.0 percent.

Basically, Mr. Fischer's speech indicates that Federal Reserve thinking has changed very little in recent years, with the exception that the projections for economic growth have been revised downwards and downwards to where they are now.

This for a world that would like to see the Federal Reserve take a more aggressive stance and even contribute to a stronger U.S. dollar.

But, the Federal Reserve is not there yet, even though it seems that they might be preparing for a December rate increase.

Unfortunately, I don't see the philosophy and tools of the Federal Reserve changing any time soon. As a consequence, the future must accept that we will just get more of the same from the U.S. central bank.

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