In a recent speech, Eric Rosengren, president of the Federal Reserve Bank of Boston, has explained why he voted against the most recent reduction in short-term interest rates. Rosengren structures his argument slightly differently, but by my count he cites four pieces of evidence for his view. The consumer price index has picked up; the interest rate, adjusted for inflation, is barely above zero; the rate is below what his Fed colleagues consider the likely rate in the long term; and unemployment is already “likely well below the natural rate.”
The first point seems to me involve looking at the rear-view mirror, and squinting. I don’t see an upward trend in the PCE, for example. Inflation expectations seem to be falling. The second and third ignore the possibility that the short-term neutral interest rate is low, reflecting a market assessment of the state of the economy that differs from Rosengren’s and may be better. And the last two reflect a confidence in the Fed’s ability to know things that we have both theoretical and empirical reasons to doubt. Its assessment of the natural rate of unemployment has, for example, fallen in recent years, suggesting that Fed policy in 2015-16 was tighter than it realized.
Rosengren says, “The market apparently believes the economy needs added stimulus to continue the expansion. My own view is different.” Markets aren’t always right, but individuals, even very well-informed and intelligent ones, should be wary of assuming they know better.