December 17, 2021

The new operating procedures have too many moving parts and no discipline to force the Fed into acting quickly. As we already mentioned if the forward guidance forecast proves accurate, the Fed will avoid the costs associated with the monetary disturbances. The possible weakness of this strategy is the Fed forecasting record. We even Jerome Powell seems to have acknowledged in the record is not particularly great. One question left unanswered is what is the inflation outlook going forward? Directionally we agree with the FMOC inflation forecast. But will there be surprises. We think so. The Fed will tailor its degree of financial repression to the real GDP forecast. The best description for the FMOC forecast is one of an initial recovery surge followed by a convergence to the long run values. We then ask a simple question, which outcome is more likely? The real GDP outperforming or underperforming the FMOC forecast. We argue that early during the recovery the underestimation of the real GDP growth rate was a likely outcome, but as time goes on and the economy approaches its long run secular growth rate, the likelihood of underestimating the real GDP growth rate declines. Since we believe that we have reached that convergence phase. As a result we going forward we expect that the Fed will overestimate the real GDP growth. That in turn will set a financial repression policy that is going to be too restrictive for the realized real GDP growth rate. The implication yielded by this analysis is for the inflation rate to come in well below the Fed forecast.

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