It is not just the monetarists who are fretting, though they are the most emphatic. To my knowledge, three former chief economists of different stripes from the International Monetary Fund have raised cautionary flags: Ken Rogoff, Maury Obstfeld, and Raghuram Rajan.
The New Keynesian establishment is itself split. Professor Krugman warns that the Fed is relying on backward-looking measures of inflation – or worse, “imputed” measures (shelter, and core services) – that paint a false picture and raise the danger of over-tightening.
Adam Slater from Oxford Economics said central banks are moving into overkill territory. “Policy may already be too tight. The full impact of the monetary tightening has yet to be felt, given that transmission lags from policy changes can be two years or more,” he said.
Mr Slater said the combined tightening shock of rate rises together with the switch from QE to QT – the so-called Wu Xia “shadow rate” – amounts to 660 basis points in the US, 900 points in the eurozone, and a hair-raising 1300 points in the UK. It is somewhat less under the alternative LJK shadow rate.
He said the overhang of excess money created by central banks during the pandemic has largely evaporated, and the growth rate of new money is collapsing at the fastest rate ever recorded.
What should we make of last week’s blockbuster jobs report in the US, a net addition of 517,000 in the single month of January, which contradicts the recessionary signal from falling retail sales and industrial output?
The jobs data is erratic, often heavily revised, and almost always misleads when the cycle turns. In this case a fifth of the gain was the end of a strike by academics in California.
“Employment didn’t peak until eight months after the start of the severe 1973-1975 recession,” said Lakshman Achuthan, founder of the Economic Cycle Research Institute in the US. “Don’t be fooled, a recession really is coming.”
Is the Fed’s Jay Powell right to fear a repeat of the 1970s when inflation seemed to fall back only to take off again – with yet worse consequences – because the Fed relaxed policy too soon the first time?
Yes, perhaps, but the money supply never crashed in this way when the Fed made its historic mistake in the mid-1970s. Critics say he is putting too much weight on the wrong risk.
It is an open question whether the Fed, the ECB, or the Bank of England will screw up most. For now the focus is on the US because it is furthest along in the cycle.
All measures of the US yield curve are flagging a massive and sustained inversion, which would normally tell the Fed to stop tightening immediately. The Fed’s preferred measure, the 10-year/3-month spread, dropped to minus 1.32 in January, the most negative ever recorded.
