How Long the Lag?

There's broad agreement the Fed's willingness to tell markets what they're doing or planning to do has shortened the transmission of policy. They influence financial conditions much faster.

But there's disagreement over how long it takes for that to influence the real economy. pic.twitter.com/6bs2cQCR0M

— Nick Timiraos (@NickTimiraos) January 30, 2023

Waller's View

Consider Waller's recent statement that lag has been reduced to 9-12 months. But a 9 month lag means economy has only felt March 25 bps increase. Economy will feel much more pain in next 6 months as the bigger hikes take effect. It's insane to hike more into inverted yield curve.

— Donald Woods (@DonaldW60852684) January 30, 2023

How Quickly Will Rate Increases Slow Economy?

The Wall Street Journal reports Fed’s Interest-Rate Strategy in 2023 Hinges on How Quickly Rate Increases Slow Economy

Federal Reserve officials’ deliberations this week over how much more to raise interest rates will hinge on how much they expect the economy to slow this year.

Key to those discussions at their two-day policy meeting will be estimating how much their previous rate increases will cool growth and inflation over time, or what Nobel Laureate Milton Friedman called the “long and variable” lags of monetary policy.

“There will be a lot of thinking about ‘Are the effects we’re getting about on the track that we expected? Are they coming sooner, or are they coming bigger?’” said William English, a former senior Fed economist who is a professor at the Yale School of Management.

Competing Views 

1. “We’re in a different world from the last several business cycles,” said Donald Kohn, a former Fed vice chairman. “The last several cycles haven’t had pandemics and land wars in Europe in them.”
2. “I think we’re seeing a lot of the impact for monetary policy coming through in the next quarter,” Mr. Waller said.
3. Economists at Goldman Sachs see shorter lags. They say markets’ pessimism is overdone, and they are among those who think the economy will prove more resilient than anticipated, which could call for a longer period of higher rates. 

I am not sure what Donald Kohn's view says or means. 

Waller's view makes the most sense to me. 

Regarding point 3, the Goldman Sachs view, where precisely is the pessimism? It's certainly not in the stock market.

And shorter lags mean a longer period of higher rates?OK. then what precisely is the stock market counting on. 

The Right Question

Are we really asking the right question?

It's not really a matter of how quickly rate increases will slow the economy, but rather how quickly rate increases will slow inflation.

I don't know the answer, nor does anyone else. 

But the higher rate hikes go and the longer they stay there, the worse the prospects are for the stock market. 

Earlier today I commented "On top of it all, how the Fed can untangle this inflationary mess is a mystery. The negative impacts of QE cannot be easily undone."  

The same applies to a myriad of free money handouts, eviction moratoriums, food stamp increases, etc. If that line of thinking is accurate, stocks are extremely overvalued. 

For discussion, please see Why Do We Have Reduced Participation in a Labor Shortage Environment?

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