- Last week's economic data continue to imply that the economy grew 3 to 4 percent annualized in the fourth quarter. And the federal deficit fell to 3.3 percent of nominal GDP in calendar 2013, a major improvement from 2009 when it reached 10 percent.
- This week's light economic calendar features jobless claims and a January report on manufacturing activity.
- Even as the economy appears to be speeding up, the Fed is sending out a new message: low for longer.
- There are good reasons for this. The unemployment rate isn't an accurate measure of true unemployment. Many have stopped searching for a job at least temporarily. Doubts about the veracity of the official unemployment rate call into question the wisdom of pinning policy moves to the official unemployment rate. For another the Fed is deeply committed to its 2 percent long-run inflation target, for good reason. Inflation now is about 1 percent.
- Transitory but also cyclical factors are holding inflation down. The 2 percent inflation may require support from the Fed even as the labor market recovers.
- If policy makers harbor doubts about the benefits of asset purchases, they must be sure they can count on traditional policies-pegging short-term interest rates-to counter most future threats.
- Given the zero lower bound on interest rates, the power of traditional monetary policy depends on the differential between short- and long-term rates, which are anchored by inflation.
- The 2 percent inflation goal, if met, would be expected to anchor long-term interest rates in the in the 3½ to 5 percent range. The zero lower bound on the funds rate would give the Fed ample power to support the economy in most scenarios. Lower inflation would be a challenge.
- Japan's experience is informative. With inflation at 0 percent for the past decade and 10-year sovereign yields around 1½ percent, the Bank of Japan's zero interest rate policy provided only modest stimulus.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.