Hello Jerome Powell, We Have Questions

-edited

This is an open letter to Jerome Powell and the Fed.

Dear Mr. Powell,

In your March 8 speech on Normalization and the Road Ahead, you spoke of diversity, zero-bound interest rate problem, and the Fed's path to normalization.

You noted "Makeup strategies are probably the most prominent idea and deserve serious attention," while simultaneously admitting an "uncertain distance between models and reality".

With that admission, you raised far more questions than you answered.

Here is a series of questions from your speech to which the American public deserves answers.

Inflation Targeting Questions

  1. Given two certified bubbles that happened under 2% inflation targeting, why not a lower target of 1% or 0%, if any target at all?

  2. The implied assumption in the catch-up theory is that two errors are better than one. But how can it make sense to discuss makeup strategies when non-bubble inducing targets are not fully understood?

  3. Given the Fed has never spotted a bubble in real time, why should anyone believe we aren't in one right now?

  4. Demographics are deflationary. How does that justify a 2% inflation target or any other specific target?

  5. Prior to 1983, the BLS directly placed housing prices in the CPI. Had housing prices been in the CPI in 2004-2006, might not the Fed have been more aggressive in hiking? Doesn't the same apply more recently?

Today, Chicago Fed President Charles Evans says inflation could run to 2.5% before rate hikes are needed. There is neither justification for this or credibility behind the statement given the Fed repeated missing of targets.

Diversity Questions

Diversity should mean more than race, background, and gender.

  1. Where is diversity of thought regarding inflation if all the members are of a monetarist or Keynesian school?

  2. How is the Austrian economic viewpoint represented at the Fed given there is not a single Austrian economist?

Phillips Curve

The Phillips curve provides an excellent example of the "uncertain distance between models and reality".

A 2017 Fed Study of the Phillips Curve concluded "Phillips curve models are not relatively good at forecasting inflation on average."

Charts suggest the Phillips Curve "works" about half the time on a random basis, meaning the theory doesn't work at all.

Why do so many on the Fed place faith in discredited models?

Inflation Expectations

In your speech, you said "Persistently weak inflation could lead inflation expectations to drift downward."

Why does it matter?

Scrutiny of elastic vs inelastic items in the CPI shows it doesn't.

​Inelastic items constitute just over 80% of the CPI. Here are some questions for the Fed to ponder.

Inelastic Item Questions

Q: If consumers think the price of food will drop, will they stop eating? Will they eat twice as fast if they expect prices will rise?
Q: If consumers think the price of gas will drop, will they stop driving?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens? Will they rent two apartments if they expect the price to rise?
Q: Will consumers delay medical services if they think prices will drop? Will they have two operations if they think prices will rise?​

Elastic Item Questions

Q. If someone needs a refrigerator, toaster, stove or a toilet because it broke, will they wait two months if they think prices will decline?
Q. Better deals on TVs and computers are always around the corner. Does that stop TV and computer purchases?

Inflation Expectation Conclusions

Except in the case of hyperinflation where a person will rush to spend cash instantly, people buy consumer items based on need, not expectations.

However, people do behave differently when it comes to assets.

Asset Price Expectations

  • People do buy stocks it they believe prices will rise. They avoid stocks or sell them if they expect prices will drop.
  • People will stretch to buy a home if they expect prices to rise. They wait if they expect prices will drop.

Home Price Index vs Owner's Equivalent Rent

In 2011, I proposed an HPI-CPI model in which the Home-Price-Index (HPI) replaced the Owners' Equivalent Rent (OER) component of the CPI.

Here is a chart from 2013, created by Advisor Perspectives at my request at the time (my comments in purple).

​Towards the end of 2005, real interest rates were positive according to the CPI, but -4% according to my model.

A similar, but more current Advisor Perspectives chart suggests the same is happening now.

From 1990 until 1999, increase in home prices matched increases in OER. That divergence culminated in 2007 when people suddenly threw in the towel on buying houses.

The Fed missed the significance of the OER substitution in 1983. Had home prices been in the CPI, we would have had more aggressive rate hikes.

Three Bubbles, Two Confirmed

We have had three major bubbles since 2000.

The Fed does not see the third one now just as Alan Greenspan didn't spot the dotcom bubble and Ben Bernanke did not see the housing bubble.

BIS Study on Deflation

The BIS study Costs of Deflations: A Historical Perspective investigated output growth in numerous deflations over a 140-year period, in 38 economies.

Deflation Study Conclusions

  • The evidence from our long historical data set sheds new light on the costs of deflations. It raises questions about the prevailing view that goods and services price deflations, even if persistent, are always pernicious. It suggests that asset price deflations, and particularly house price deflations in the postwar era, have been more damaging.
  • Deflation may actually boost output.
  • Lower prices increase real incomes and wealth.

​Three Wrong Economic Models

  1. Deflation Group-Think

  2. Inflation Expectations

  3. ​Phillips Curve

At the top of the list of widely-believed but false central bank economic theories is the notion that falling retail prices are bad for the economy.

Central banks acting on those group-think beliefs attempt to modify inflation exceptions while not factoring in asset price appreciation.

Invariably, the result is bubbles.

Asset Valuation Models

Numerous metrics including the Shiller PE ratio, the Q-Ratio, and Greenspan's Valuation Model show we are amidst yet another spectacular asset bubble.​

Shiller PE Ratio

Greenspan Valuation Model

Final Key Questions

Why does the Fed ignore asset valuation models that do work over the long haul in favor of economic models that admittedly have an "uncertain distance between models and reality"?

Why, Jerome Powell?

Unlike others, I do not believe these are purposeful actions by the Fed for the benefit of banks, so the only logical answer is the Fed does not properly understand what inflation is, how to measure it, or the vast array of problems associated blowing asset bubbles.

Mike "Mish" Shedlock

Comments (25)
No. 1-16
Schaap60
Schaap60

The letter asks many important questions. I agree that in the setting of rate policy (and QE/QT) the Fed does not purposefully act for the benefit of banks, though all things being equal the Fed will do what helps the banks the most. However, isn't the payment of interest on reserves started by Bernanke a purposeful action taken by the Fed to specifically benefit banks?

WarpartySerf
WarpartySerf

Ah Janet Powell With her pointy high heels on the throat of the average citizen. A truly great representative of the totalitarian oligarchy - She exists to protect them. Good girls like her do what they are told.

RobinBanks
RobinBanks

The 10 year going below 2.4% wouldn't have happened so suddenly if Powell had shown some cojones and kept rates going up slowly. The yield curve inversion will crush bank margins so expect and even further fall in credit generation. Genius!

Mish
Mish

Editor

I sent that to the WSJ after Powell's speech. The Journal did not reply after a week

shamrock
shamrock

"Q. Better deals on TVs and computers are always around the corner. Does that stop TV and computer purchases?"

Yes. Not forever of course, could be a few months, could be a few years.

bradw2k
bradw2k

No Austrians at the Fed because they are no fun at all. Greenspan had to show he'd ditch the "hands-off" baloney of his youthful exuberance before he was let into the big boys' power club.

hmk
hmk

Its not just the banks its for the govt, the biggest debtor of all. It keeps their interest payments manageable to keep their deficit spending ponzi scheme alive and to keep the sheep from becoming to restless.

Mish
Mish

Editor

I just sent this inquiry to the Fed on their contact page:

Hello. I have some questions for the Fed that are of general interest to all Fed followers. The questions pertain to interest rate policy, bubbles, inflation expectations, and other current issues.

I am an economic writer. I posted the questions on my website.

Hello Jerome Powell, We Have Questions

The questions are to Jerome Powell. Thanks

Mike "Mish" Shedlock

sunny129
sunny129

Excellent. Mish!

lol
lol

Prices soaring,Venuzuela style,prices keep rippin higherTrump might be forced to declare a state of emergency.....yes it is that bad and getting worse......fast!

Maximus_Minimus
Maximus_Minimus

Final question: Why don't you discuss your academic theories in the cozy confines of a university, and let the real world deal with real world problems?

AWC
AWC

A possible answer?

"We own and operate the currency of the worlds largest economy. We are omnipotent, know everything and you and the markets know nothing. There will be no further questions, so, move along now."

compsult
compsult

These are great points and I am sure you will hear crickets in response. I feel for Powell, he has been painted into a corner by prior fools. If he raises rates or continues with the balance sheet reduction, it will probably weaken an already weakening economy.

With 1) $2.5T in BBB corp debt 2) 58% of Americans having savings of less than $1K, 3) 7 million auto loans 90+ days in arrears, it's kind of little red riding hood scary out there. Someday, somehow the pain will be experienced. Maybe Powell doesn't want his picture in the history books as being the architect of a massive downturn

thimk
thimk

the feds third mandate is to keep the debt incurred asset at or above nominal cost. well maybe its first mandate.

Casual_Observer
Casual_Observer

We are in uncharted waters. Given the system we have it is all an experiment. Any system would be. You are in charge of 7B lives.

Blurtman
Blurtman

The member banks committed massive fraud causing the Great Depression 2. What banana republic confirms as Treasury Secretary a criminal whose bank had to pay a record fine for massive fraud under his leadership?