John Taylor (Not The FX One, The One With The Rule) Says Fed Funds Rate Should Be 1.0%, Sees No Rationale For Further QE
A month ago, Zero Hedge first posted (well, technically we read it at Stone McCarthy but beat everyone else to copying and pasting it first), that according to the Taylor Rule, so widely abused by the lemming central planners in the Marriner Eccles building, the effective Fed Funds rates should, for the first time since the GFC, be positive. This is what SMRA said: "For the second consecutive quarter, the original-specification, quarterly version of the Taylor rule, based on real GDP figures and the GDP price deflator, produced a positive result. The previous day, the BEA released its advance estimate for real GDP figures in Q1 2011. Based on those numbers, the Taylor rule prediction for the federal funds rate target in Q1 2011 is +0.4%. In the previous quarter of Q4 2010, the Taylor rule prediction was +0.1%."
Now, Taylor himself, in his blog, confirms that not only should the Fed Funds rate be positive, it should be 1%.
- Over here at Economics One, I can report that the Taylor
Rule says that the fed funds rate should now be 1 percent, and I can
provide the calculations. Available data (through the 1st quarter) show
that the inflation rate is about 1.6 percent (GDP deflator smoothed over
four quarters) and the GDP gap is about 4.8 percent (average of San
Francisco Fed survey). This implies an interest rate of 1.5 X1.6 +
.5X(-4.8) + 1 = 2.4 - 2.4 +1 = 1.0 percent. I am not sure why other
reports differ, but at least the coefficients and numbers are here to
see and check. Perhaps they are using different coefficients, but David Papell writing at Econbrowser earlier this month showed why the coefficients reported here work well.
I think the economy would be better off if the Fed started moving to a
higher funds rate now rather than later, and I certainly see no
rationale for another round of quantitative easing. Unfortunately, it
looks like the Fed will continue with its zero interest rate for a while
longer, and traders will continue to debate whether or not there will
be a QE3 adding volatility to the market.
It is ironic, then, that Taylor speaks up just in time for Jan Hatzius and Bill Dudley to start their behind closed doors meetings which will usher in QE3. After all, we have now gotten to the point where Hank Paulson will be brought out of retirement and paraded in front of Congress waving a 3 page term sheet demanding a blank check should the Russell 2000 retrace below the 100 DMA.
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