Chief economist update: Two indicators giving the Fed a headache

It appears nothing is normal with the Fed's march toward normalising monetary policy.

Not only has it stopped in its tracks, the White House wants it to go in reverse. Cue US President Trump's latest "advice" to the Fed: "In terms of quantitative tightening it should absolutely now be quantitative easing".

And days before that, White House economic adviser Larry Kudlow made it known he wants the Fed to "immediately" cut interest rates by 50 basis points.

What's a Fed chair to do? What else but go back to its statutory dual mandate - price stability and maximum employment.

The St. Louis Fed explains: "The FOMC interprets an inflation rate of 2% as consistent with price stability. As such, the FOMC adopted an explicit inflation target of 2% in January 2012."

Which inflation measure? The Fed's target is based on the annual change in the overall, or "headline," PCE price index.

As Bullard wrote in a 2012 Regional Economist article: "The FOMC will target the headline inflation rate as opposed to any other measure (e.g., core inflation, which excludes food and energy prices) because it makes sense to focus on the prices that U.S. households actually have to pay."

Repeat: the Fed tracks the HEADLINE PCE price index, not the CORE. Looking at the time series picture, Trump and Kudlow have valid points.

The annual rate of growth in the headline PCE price index peaked at 2.3% in May 2018, dropped below the Fed's 2.0% target in November and continued to slow to 1.4% by February this year. The more stable core PCE price index peaked at 2.0% in July last year and has decelerated to 1.8% in February.

And maximum employment? Let's hear from the horse's mouth, "In the FOMC's March 2019 Summary of Economic Projections, Committee participants' estimates of the longer-run normal rate of unemployment ranged from 4-4.6% and had a median value of 4.3%."

The latest US non-farm payrolls report put the unemployment rate at 3.8% in March - the 19th straight month that the jobless rate had been below the "median value of 4.3%".

The outlook for jobs remain positive gauging from the March consumer confidence survey showing respondents saying "jobs were plentiful" remaining close to 18-year highs while those thinking that " "jobs were hard to get" (also within 18-year lows).

Needless to say, these strong labour market indications argue against Trump and Kudlow's prescriptions.

The rising divergence between inflation and employment is what keeps Powell up at night, not the president and his economic adviser.

Read more: Larry Kudlow
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