Is The Fed Holding Down Growth? (Just The Opposite)

I occasionally get comments suggesting that the Fed is somehow “holding down growth” in the economy. That makes me wonder if the Fed has some sort of magic dust, capable of holding down growth without leaving a trace. So let’s look at some of the traces the Fed has actually left.

Before doing so, recall that some conservative economists claim that the Fed has no first order impact on growth, because money is neutral. I don’t agree, and neither do those who claim the Fed is holding down growth.

More likely, wages and prices are sticky in the short run. The Fed can temporarily boost growth by increasing the rate of inflation, and thereby reducing the unemployment rate. I’ve argued that we should look at NGDP growth rather than inflation, which can be distorted by supply shocks.

So let’s look at the data:

1.  Over the past two years, the unemployment rate has fallen all the way to 3.7%, one of the lowest rates in modern history. Other employment indicators have also been quite strong, with employment rising far faster than the working age population.

2.  Over the last two years, inflation has risen up to around 2%, roughly the Fed’s target.

3.  Most importantly in my view, the rate of NGDP growth has been increasing rapidly, from well below trend to above trend:

Screen Shot 2018-12-07 at 1.22.55 PM

One can’t just argue that the Fed is holding down growth, without providing any evidence. All the evidence points in the other direction, that the Fed has been juicing the economy. Perhaps that will change in the future, time will tell. But they have certainly not been holding down growth in the recent past, precisely because they haven’t been taking the steps that would be necessary to hold down growth—slowing NGDP and inflation in order to raise the unemployment rate.

Some will inevitably argue that there has been a supply-side “miracle” that’s hard to see because the Fed refuses to “let the economy rip”. Supply-side miracles leave very specific tracks in the data, such as a slowdown in inflation. But inflation has been rising. And of course, that doesn’t explain the strong NGDP data.

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