Janet Yellen is shocked that the Fed’s price models don’t work

Posted: Apr 27, 2014 12:01 AM

So are we. Just shocked.

Hey, at least she said it publicly. That’s more than Mr. Bernanke ever did.

Ms. Yellen says doesn’t understand why inflation is running hotter in the US than her models say it should be and why it ran cooler in Japan recently than her models predicted.

Models, it’s always the models with Keynesians.

Many modern economists like to think of themselves as scientists, or at least something close to scientists. But instead of white coats they wear tweed jackets and instead of verifiable results they produce excuses.

Ok that’s a bit harsh but it’s not far from the truth.

Some believe that Yellen is too enamored with a “natural rate of unemployment” that is too low. That she thinks the rate of unemployment where wages will start to drift up and which represents mostly transitional movement between jobs and not layoffs in the economy is around 5.5%. But others think the natural rate is closer to 7%.

If the natural rate is closer to 7% and the official employment rate is at 6.7% (as the Fed says it is now) then that means there may be serious pressure on prices to move northward long before we get into the 5.5% range. (If we ever do.) This could spur significant upward pressure which in turn will necessitate harsh interest rate moves up in the future to get things under control. (They are never “under control.” Prices, even strongly manipulated ones are never under control.)

Add that Yellen also said recently that the employment number coming from the Fed wasn’t particularly accurate and one can see why brows are furrowed around the table of the FOMC.

Pretty much it all comes back to the fact that the equations which never work for the folks at the Fed are not working yet again.

(From Bloomberg Businessweek)

“We remain far from having a full understanding of the recent behavior of inflation,” wrote the Romers, who are professors of economics at the University of California at Berkeley. Christina Romer is also a former chair of President Barack Obama’s Council of Economic Advisers.

Yellen referred to the conundrum in her speech last week. “During the recovery, very high levels of slack have seemingly not generated strong downward pressure on inflation,” she said. “We must therefore watch carefully to see whether diminishing slack is helping return inflation to our objective.”

There are a number of possible explanations here. 1 that there isn’t as much slack as Ms. Yellen thinks as noted above. 2 that the nature of “slack” has changed in a somewhat post industrial society with all sorts of welfare state provisions, which was also sort of noted. Add in people hiding in college with loans, the emergence of the Obamacare part-time army, and the Internet DIYers and things don’t fit the models conceived even 10 years ago. (Of course they never did.)

And don’t forget the ether through which all of these factors move, Quantitative Easing and the complete undermining of the pricing mechanism of capital in the economy. That might make things hard to figure out too.

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