Powell Is Concerned About Dots


In Jerome Powell's speech on Friday, he displayed a huge concern over the dot plot, an estimation of future rate hikes.

The dot plot is an estimation by Fed participants of the path of future rate hikes. Powell is concerned about the plot. After all it has been practically useless.

Powell talked at length about dots in his speech on Friday Monetary Policy: Normalization and the Road Ahead.

As readers of the FOMC minutes will know, at our last meeting in January there was an impromptu discussion among some participants of general concerns about the dots. My own view is that, if properly understood, the dot plot can be a constructive element of comprehensive policy communication. Let me follow my two predecessors as Chair in attempting to advance that proper understanding.

Each participant's dots reflect that participant's view of the policy that would be appropriate in the scenario that he or she sees as most likely. As someone who has filled out an SEP projection 27 times over the last seven years, I can say that there are times when I feel that something like the "most likely" scenario I write down is, indeed, reasonably likely to happen. At other times, when uncertainty around the outlook is unusually high, I dutifully write down what I see as the appropriate funds rate path in the most likely scenario, but I do so aware that this projection may be easily misinterpreted, for what is "most likely" may not be particularly likely. Very different scenarios may be similarly likely. Further, at times downside risks may deserve significant weight in policy deliberations. In short, as Chairman Bernanke explained, the SEP projections are merely "inputs" to policy that do not convey "the risks, the uncertainties, all the things that inform our collective judgment."

Effectively conveying our views about risks and their role in policy projections can be challenging at times, and we are always looking for ways to improve our communications. I have asked the communications subcommittee of the FOMC to explore ways in which we can more effectively communicate about the role of the rate projections. For now, let me leave you with a cautionary tale about focusing too much on dots. Here is a picture composed of different colored dots (figure 2). The meaning of it is not clear, although if you stare at it long enough you might see a pattern. But let's take a step back (figure 3). As you can see, if you are too focused on a few dots, you may miss the larger picture.

Dot Plot Figure Three

Obvious Problem

The obvious problem is the Fed's dot plot looks nothing like either. And it has been hugely wrong.

The reason is obvious. The Fed has no idea what it is doing or where interest rates should be anymore than it knows how many cars GM should produce.

Concern Over Zero Bound

Moving beyond the discredited dot plot, Powell is also concerned about policy decisions when interest rates are close to zero.

When a recession comes, the Fed is likely to have less capacity to cut interest rates to stimulate the economy than in the past, suggesting that trips to the ELB [Effective Lower Bound] may be more frequent. The post-crisis period has seen many economies around the world stuck for an extended period at the ELB, with slow growth and inflation well below target. Persistently weak inflation could lead inflation expectations to drift downward, which would imply still lower interest rates, leaving even less room for central banks to cut interest rates to support the economy during a downturn. It is therefore very important for central banks to find more effective ways to battle the low-inflation syndrome that seems to accompany proximity to the ELB.

In the late 1990s, motivated by the Japanese experience with deflation and sluggish economic performance, economists began developing the argument that a central bank might substantially reduce the economic costs of ELB spells by adopting a makeup strategy.9 The simplest version goes like this: If a spell with interest rates near the ELB leads to a persistent shortfall of inflation relative to the central bank's goal, once the ELB spell ends, the central bank would deliberately make up for the lost inflation by stimulating the economy and temporarily pushing inflation modestly above the target. In standard macroeconomic models, if households and businesses are confident that this future inflationary stimulus will be coming, that prospect will promote anticipatory consumption and investment. This can substantially reduce the economic costs of ELB spells. Researchers have suggested many variations on makeup strategies. For example, the central bank could target average inflation over time, implying that misses on either side of the target would be offset.

By the time of the crisis, there was a well-established body of model-based research suggesting that some kind of makeup policy could be beneficial. In light of this research, one might ask why the Fed and other major central banks chose not to pursue such a policy. The answer lies in the uncertain distance between models and reality. For makeup strategies to achieve their stabilizing benefits, households and businesses must be quite confident that the "makeup stimulus" is really coming. This confidence is what prompts them to raise spending and investment in the midst of a downturn. In models, confidence in the policy is merely an assumption. In practice, when policymakers considered these policies in the wake of the crisis, they had major questions about whether a central bank's promise of good times to come would have moved the hearts, minds, and pocketbooks of the public. Part of the problem is that when the time comes to deliver the inflationary stimulus, that policy is likely to be unpopular--what is known as the time consistency problem in economics.

Two Mistakes Better Than One

In the above paragraphs, Powell discusses a possible need to purposely err in the opposite direction if the Fed cannot hit its inflation target.

In short the Fed says two mistakes may be better than one.

I believe the average third grader could understand the complete silliness of such a discussion, but economic wizards live in Fantasyland where normal observations occur.

Instead of discussing such obvious silliness, the Fed ought to step back and consider a simple set of facts.

Four Simple Facts

  1. There is no economic benefit to inflation.
  2. Even if there was a benefit, there is no way to know what the target should be. Why 2% and not 1% or 0%?
  3. Even if one could magically divine a proper target, the Fed would be constantly chasing its tail playing catch up top the markets.
  4. Finally, there is no way to properly measure inflation in the fist place because the Fed does not see asset bubbles as the direct result of its inflation policy.

Repeated bubble blowing episodes that benefit only the bankers and asset holders is proof enough of how piss poor Central bank policy has become.

My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

Also note that the BIS did a historical study and found routine deflation was not any problem at all.

Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive, stated the BIS.

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Mike "Mish" Shedlock

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As one who is generally bemused by people's constant complaints about the Fed, I finally have reached the conclusion that some some inexplicable reason, some people think that the objective of the Fed is to help them. Remember that the Fed is owned by banks, and is a part of the banking system. Although the Chairman is appointed by the President, the Fed is NOT a part of government. It owes no duty to the general population. It's objective is to maintain an orderly financial system because an orderly financial system is beneficial to banks.

Mish often argues that there is no benefit to inflation. Is there no benefit? Is there harm to deflation? If you were looking at consumers, Mish would be correct, but it isn't the job of the Fed to do that. If you are looking at it from the perspective of banks, as the Fed is, there is a clear benefit to banks from slight inflation, and a clear harm from deflation. Inflation causes asset values to rise, and assets are the collateral that banks use to secure their loans. In a slightly inflationary world, loans are less risky. In a deflationary environment, collateral falls in value, and loans are more risky.


The prices of assets have clearly increased greatly due to low interest rates, something that a purist definition of inflation (money supply) or an artificial definition as practiced by the Fed, would deny. But reality is reality. We have had real world inflation for quite a while.

C. P. Roberts
C. P. Roberts

The central bank was made to help banks and banks alone. C.B.s enslave the world and take the profits