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"The Output Gap Appears Closed" - The Fed's Model Just Confirmed A December Rate Hike
Back on July 24, as we first wrote then, the 2 Year bond yield suddenly tumbled just before noon...
... when it was discovered that "accidentally" the Fed released its confidential, policy-driving economic projections, alongside its public forecasts, as calculated by the Federal Reserve's FRB/US computer model.
These were far more dovish than most, at the time, expected and certainly far worse than the Fed's public computer model data indicated. To wit: "While superficially, and as expected, the Fed is assuming a 1.26% fed funds rate in one year, suggesting about 3-4 rate hikes until then, with the first one according to the leaked documents taking place in Q3, the overall strength of the economy is well weaker, and thus more dovish, than many of the permabulls had expected."
This led to a sharp repricing of both short-term rates and inflation expectations. Four months later we find that, at least one, the Fed's model was right, ironically this happened when it had predicted a slowdown.
As a reminder, approximately every three months, Federal Reserve Board staff update and publish on the Board's website a package of computer code of the Board staff's FRB/US model of the U.S. economy, including a set of illustrative economic projections based only on publicly available information.
On June 29, an updated package of code was posted that inadvertently included three files containing staff economic forecasts that are confidential FOMC information. Two files contained charts of the staff's projections for economic variables such as the unemployment rate, the core inflation rate, and gross domestic product growth as well as the staff's assumption for the path of the federal funds rate target selected by the FOMC. Another file contained computer code used to generate a table displaying staff economic projections.
Three months after the July 24th fiasco, this Friday afternoon the Fed released an updated set of FRB/US outputs which this time may have precipitated the late day selloff as the results showed a vastly different picture than the one revealed in July. The model also may explain the unexpectedly hawkish tone in the Fed's October statement.
In short: the model validated concerns that the Fed may hike rates in December because the Fed's take, at least as modeled under Excel, is that the "slack in the US economy has substantively disappeared." This is shown in the chart below which shows the dramatic divergence between the last and most recent FRB/US forecast on the US output gap.

To explain the chart above, Bloomberg cites Barclays' chief US economist Michael Gapen (who previously worked at the Fed) who pored through the Fed model data, "the output gap appears closed. This means further progress would lead to resource scarcity and potential upward pressure on inflation in the medium term."
Gapen said that may explain why U.S. central bankers signaled this week that they will consider the first interest-rate increase since 2006 at their next meeting, on Dec. 15-16. Finally, "the model assumes that the Federal Open Market Committee raises the benchmark lending rate in late 2015."
Which leaves the one and only FOMC meeting left this year: that on December 15-16.
Some more details from the Barclays note:
According to the bank, "the updated output is consistent with near-term liftoff of the fed funds rate, with a risk toward a later liftoff should further softness in inflation manifest. The model now shows much less assumed cyclical slack in the economy and has a softer path of inflation, highlighting the FOMC’s current dilemma as the two parts of their objective move in opposite directions."
Barclays ran the FRB/IS model using the most recent data, and had the following additional take-aways:
Figure 1: The fed funds rate: FRB/US now assumes that the FOMC increases the fed funds rate in late 2015. We see this lift off as consistent with a December rate hike. Of note, FRB/US, like all other state space or DSGE models of the economy, calls for an immediate and rapid liftoff of policy rates. This immediate lift off has been a feature of FRB/US output since late 2014. The models see most variables as close to their long-run levels and hence the model calls for a return of interest rates to their long-run level (in other words, models do not take into account latent headwinds such as financial frictions or credit constraints in the economy).
Of note, all variables in the model must converge to long-run levels imposed by staff. At least in the assumptions used for this public version of FRB/US, the staff sees the long-run level of the funds rate at 3.5%, down 25bp from their previous release. This estimate is still higher than our belief (3.0 to 3.25%) but has gradually converged toward our estimate. The staff’s current assumption is down from the 4% level assumed by the Board as recently as late last year.
Figure 1: Funds path consistent with December

Figure 2: The unemployment rate: The staff moved the long-run level of the unemployment rate (NAIRU) lower in the October 30 release of the model. At 4.9%, NAIRU is two-tenths lower than in the previous version of the model. The lower level of NAIRU is consistent with the views of the committee as expressed in the SEP. The SEP shows the long-run level of the unemployment rate at 4.9%. With unemployment currently at 5.1%, FRB/US assumes very little change in the unemployment rate over time. This view is quite different than ours. We forecast ongoing declines in the unemployment rate and see it reaching 4.3% by end 2016.
Not shown in the output of the model, the stability of the unemployment rate implies either an increase in the LFPR (labor force participation rate) or a sharp slowing in employment growth. According to our estimates holding LFPR constant, the level of employment growth that keeps the unemployment rate constant is 76k per month. Alternatively, an increase in LFPR of about 0.7pp would allow NAIRU to stabilize with employment growth near its recent average.
Figure 2: NAIRU pushed down to 4.9%

Figure 3: Core PCE inflation: The updated path for core PCE inflation closely matches our current forecast. In our forecast, the stabilization in oil prices should lead headline inflation to rebound early next year, but we look for recent dollar appreciation and ongoing declines in Chinese producer prices to lead to a moderation in tradable goods inflation through mid-2016. The release of September PCE inflation this morning is consistent with this view, as the sharp drag from goods prices (-3.2% y/y) led to an unchanged year-on-year rate of core inflation at 1.3%. The FRB/US model agrees and shows the firming in core inflation as giving way to a modest softening through mid-2016. As shown in Figure 3, the October 30 path shows a shallower path from Q1 16 through Q4 17 than the previous FRB/US update.
Figure 3: PCE inflation slightly lower

Figure 4: Real GDP growth: The October 30 update for FRBUS also shows a slower growth profile after this year and a lower long-run potential growth rate. As shown in Figure 4, the updated path has y/y rates of economic growth gradually slowing from 2.5% in Q1 16 to 2.1% in 2020. Based on FOMC communications, including minutes to recent FOMC meetings, we believe the shallower growth path likely reflects greater assumed dollar appreciation. In addition, the long-run growth rate is two-tenths lower than the previous FRB/US update (2.1% now versus 2.3% previously). Since this growth rate at the end of the horizon is imposed by staff, we interpret this as suggesting staff has likely reduced its estimate of potential growth, as did FOMC participants in the September forecast round.
Our view of potential growth is more pessimistic at about 1.5%, but our estimate is weighted heavily to current trends and is not equivalent to the Fed’s long-run estimate. Board staff have likely assumed that productivity growth, which has been much slower in the post-recession environment, rebounds over time as headwinds to the US economy dissipate. We do not discount this possibility, but leave this as an open question for the data to resolve over time.
Figure 4: Real GDP growth slows after this year

And the most important chart: The output gap: Board staff now see the output gap as closing by Q1 2016. To achieve this closing especially given their mark down of real GDP growth, they sharply lowered their estimate of potential growth in 2015. This change likely has policy implications as it indicates a staff view that there is no longer substantive slack in the US economy.
Figure 5: Potential output slashed to close output gap despite slower growth profile

* * *
Finally, just in case someone is skeptical that any of the above computer simulations just "might" be wrong, here is an example of the code that gives the Fed a better understanding of reality than reality itself.
As it turns out, everyone does live in the Matrix. The Fed's "model" matrix that is, which at least to the Fed is far more important than the "reality" some 99% of the US population live in, those who never benefited from the Fed's generous injection of $3 trilion in bank reserves.
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model shmodel - I've been suggesting that a small hike before the bulk of the holiday shopping season makes eminent sense - plenty of debt creation cover, and when Feb/March role around, they have somewhere to go again - punting, of course.
but they can be seen to be doing something, signal 'confidence' and all that shit.
Meanwhile, I'll be shorting the dollar.
When alien anthropologists dig up the charred remains of western civilization's historic record, they will state that Keynsian Economics was a strange and destructive religious cult.
Listen, those pussy Fed officials are not going to raise rates. Its all theater, the US economy is slowing, the world economy is slowing. Only a fucking retard would raise rates.
So you are saying they are rational?
So,...
They're saying the 'slack' in the economy has vanished, and that, going forward, there will be greater demand for labor and materials?
Wage-Push Inflation?
HAHAHAHAHAHAHAHAHAHAHAHAHAHAHA!!!!!
Good One! I love a good joke.
Rate Increase in December?
HAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHA!!!
[Not Gonna Happen]
We are ALL Japan now...
Are we to believe the Fed will live in-matrix, simple again so everyone would be chart-following again, instead of living in off-matrix, un-normal not-real world of the ptb (er, front-running fed)?
11.3, 11.5 to 12.16 is almost 7 weeks away, hummmm. Let’s wait see…
Get ready to buy Real Estate after the initial shock. Then sell it all back into the market when rates are cut next spring.
Japan, the EU and China will still be printing -- I mean, QEing. Higher rates will make US bonds and the dollar more attractive. So, a flood of fiat will be heading to the US. I won't be surprised if that is bullish for stocks and real estate.
Only when rates are up a few percent, do I expect much of an impact on markets. For a couple of years, volatility but little movement overall -- like this year. The fed will move very slowly and not make too many waves. They raised rates in a hurry in 80-82 because inflation was insane because the dollar recently lost it's gold backing.
If I'm wrong, I have dry powder to buy real estate or beaten down stocks/bonds. No cares either way.
Sane people would put the prime rate at 5% then get the hell out of the way.
No bailouts, no QE, let the banks/corporations/insurers collapse and individuals pick up the pieces.
Prosecute fraud, end the FED, jail Jon Corzine, and tell Wall Street and the Hamptons to suck it and find a real job.
Looking at these charts, Yellen may as well come to the next press conference with a twig and branches dowsing rod and wander around the room.
No way you could become president with all that truth.
(Sigh).
All a girl can do in this environment is dream.
agreed. I think the future will marvel at the sheer obviousness of its flaws.
3% FFR in 2018?.....you have to be smoking the matrix
I just left an output in the toilet that pointed right down the drain, and then the toilet flushed. Thus, my charts and models point to negative rates within 1 year.
The bull trap snaps shut soon, very soon. So much bull blood will e spilled.
I decided that there WILL be a December lift off as soon as I saw the notice from my credit card company that the interest rate on card balances is going UP from 19% to 25%. Don't fight the fed.
I got the same bullshit! December it is.
Silly me, I thought usury was illegal in the USA...
I got a similar one about cash back rewards(AmEx) going up. My first thought was, 'how are they going to pay for this?'. The banks are loaded w/ reserves;
https://research.stlouisfed.org/fred2/series/EXCSRESNS
Now they can raise rates to boost profits. Reserve rates, too.
http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm
A big long fancy comlicated scary looking formula like that can't be wrong.
Does any of this really matter? We all know the market will go UP not down when they raise rates. Same shit since 2009.
On the flip side, if they don't raise they will also make the market go up. Vix will be bitch slapped, algos will key off it and....BAM.
So they have finally found some inflation in the system then? They haven't been able to find it in the grocery stores, the housing price and the rents but now they think it is threatening somewhere 'significant'?
and this low employment rate doesn't mean anything since most of the jobs are minimum wage servers. Until businesses start competing for workers with higher wages this jobs recovery is filler for the better paying jobs lost by this incompetent central bank
one could only hope it all crashes down before Dec
just to show the FOMC they AIN'T all that,and a bag of chips
irony in 3...2...
The world's most expensive work of fiction.
Under the assumption this is the new normal and those peeps never return to the labor force they are correct. Do they know something the rest of us don't?
Astute.
No longer substantive slack in the economy? Lololol. What is this?
https://www.google.com/url?sa=t&source=web&rct=j&url=http://www.zerohedg...
Plus the quality of jobs in this new economy is nowhere close to the old economy.
Those jobs are never coming back, so it's the slack at that new level where half of all Americans are left in a gutter.
Unless by some miracle, Trump gets elected AND he's willing and able to send home all the illiegals and H1Bs. The prez can't change much without congress, and we know they are all bought and paid for by corps out to nuke the working class.
I put this scenario at 1 in a million, but I guess that's something. Count on it like you count on winning the lotto.
Does Trump have 32.8 TRILLION?
https://app.box.com/s/hfgvcqg7gqh7i27at6sv53ywu87lwarp (Read Me First)
Words are cheap. 3x the GDP of China talks ..
The chance to raise rates has come and gone. God knows what will come next, and he's shorting everything
That's a hell of a lot of bullshit.
Don't tell me the FED are starting to believe their own propaganda.
They still haven't worked out that the US is in recession.
To raise rates is to risk a sudden "waterfall" equity market drop, August 2015- or even "flash-crash"-style. To have that risk in December, right before the busiest holiday shopping weekend woudl be to throw away 7+ years of extreme efforts by the Fed to instill "con-fidence" and not to "disturb the markets." Regardless what the models show, they'd rather risk raising faster in 2016 than doing it right before the holidays, especially if the winter proves to be, you know, like, cold and snwy and stuff...
I've consulted a 2003 NORFED round....
She came up heads.
Rates will be raised.
After 7+ years of building buffers, the bankers and their friends can weather a small "loading up" period...
"slack in the US economy has substantively disappeared."
The FED is DELUSIONAL! This economy is in a full blown recession, just because people stop looking for a job, doesn't mean all of the slack is gone.
WWW.USDEBTCLOCK.ORG
Reality that things are getting better, when the U.S. debt clock stops going up by the TRILLIONS!!!!!!!!!!!!!!!!!!!!!
It really only depends on how you measure it like unemployment, if people do not count for the figures and thus the incurred cost.
Wow a fantastic idea, drag all the banksters out and shoot 'em then we can say they cost us nothing. Hell we even managed to stop them stealing WITHOUT legislation.
One man's delusion mine is another man's dream ... do dream's come true?
Who owns the shares in the regional banks again?
I mean as long as its not a consortium of foreign banks or something, I'm sure the Fed will see us through this crisis caused by Putin and the Palestinians.
Now no NIRP?
I don't care what they make the stupid Rate. I won't borrow another penny from a stinkin criminal bank until half of em are in jail and the other half are closed. Clean it up and we'll talk, until then its cash and carry. Nor will I leave more than a monthly bill allowance inside a derivative time bomb. See ya with my camera at the ATM lines. Don't forget to SAY CHEESE.
On a lighter note: I Paid an outrageous 22 dollars for a of box some full size(actually looked1/2size) candy bars for the kid Trick or Treaters. I left the lights on until midnight and for the first time ever, not one kid came. What gives? Economic Indicator? Everyone to broke to come or what? Strange. It Sux, me or my hound dogs don't like chocolate, Ole Blue and Trailer won't touch it. Should have bought some bags of jerky or nuts or something.
Charcoal works good in the stove when the heat goes off.
My heat don't go off. 5 ton electric heat pump and 2 500gal propane tanks used mostly for equipment and 10 ricks of firewood backup.
Cacao is poison to canines, you might just have very smart dogs... most will eat the choco (cause it came from your hand, and they trust you), then they stop breathing...
Please stop trying...
Whereas processed sugar is poison to us humans (according to our chemistry), so all in all, I recommend donating it to your local church, but that's coming from my dislike of the establishment religistructure.
You don't know jack about Hound dogs son,. Might kill your little shitzu lap licker but its pretty hard to kill dogs that fight wild hogs for a livin or run 40 miles in mountains non stop. I had one that got bit about 20 times trying to fight a rattle snake in a barn. Head looked like a basketball then next day. Did not even drink so much as water for over 2 weeks and did not get up for over two months. messed him up for life, gave him joint problems like ruematism but he died of old age. That enough poison for your little internet wives tale?
R.I.P. Boss Man
Oh and PS I have over 250+ large animals currently and have cared for as high as 600-700 at a time + 50-60000 poulty per house. I have forgotten more about forage, feeding and animal nutrition than you will ever learn.
You clue should have been my internet name dipshit. This site is completely overran with complete dumbasses these days. Ran off all the good posters.
I haven't seen kids out trick or treating FOR DECADES. The parents are scared of terrorists, rapists and probably their own shadows. Not to mention cops who will take your kids to a foster home if you even let them play by themselves.
Certainly not like the days when we kids went out and brought back enough candy to last the whole year.
I think a big dog would have to eat a lot of chocolate to have serious issues. Maybe after a few candy bars they puke, but not much more.
I hope your operations are important enough that the banks really miss your loan business. The ones getting fed assistance don't give a damn about losing a few loans. All their risk is on us.
Nah Im not big enough to hurt their feelings one bit anymore. Went from 7000ac( most leased from of all people a stinkin banker lol) + 4- 60k bird chicken houses in my prime, to 800ac and no houses 20yr ago. Tysons thought they were going to tell me how to run my own business on my own land. Their old houses have hay bales and equipment in em now.
I got lucky and sold 220ac this year, Im down to 420ac, a few buffalo for hobby, some feeder steers and couple of horses now. Been trying to unwind, I want to leave, Tired of the way people act now and the way our gov't does and see nothing left worth fighting for, I don't want to support it for moral reason. Still got maybe 2=3 years to go.
They don;t care if they loan me or you money nowdays, and they dang sure dont want it back.
Kids still halloween here... still relatively nice place. Ive seen hunting type dogs wolf down an entire stale chocolate cake when I was a kid. did'nt faze em. people read this horseshit on the internet. Not something you would feed em though or to maybe a pedigree snauzer. lol glty.
It is simply amazing to observe the gravity-defying contortions play out in this Punch & Judy show, all in an effort to - what...? The only substantive reason I can think of is that geopolitical events (that are rapidly laying down a less-than-rosy future for the $USD), must be on the radar of the Fed. There is no way in bloody hell that the Fed is simply looking at global economic issues, without taking into account (from various agency advisory staff), the impact of geopolitical events.
Geopolitical events are one of the main reasons the Fed's hands are tied: the US$ is already too strong against many world currencies whose central banks have all been CUTTING rates lately. If the Fed dares raise rates, the extra strength of the US$ will kill what's left of our export industries.
Rate Hike in December isn't gonna happen...
Those "models" are only taken seriously when they tell the people who matter what they want to hear. When they don't, they're ignored.
It really is becoming a "I don't care moment for whatever descision they make" kind of thing.
We can judge them on the results and then try them for that along the line ...
Moms and Pops invested in the economy but frankly lost everything because of the FED's like all other central banks deceitful figures. Let the banksters put their money where their mouth is, you strip them of all assets and worth and hand it to the mom and pops as compensation. Every cent so none of their kin can inherit the stolen wealth from the population neither.
Not got a problem with the last part so long as the Banksters pay on the way out in full.
I think the only conclusions from this FED bumbling BS is that they really don't know what they are doing, except they realize they are getting squeezed by increasingly limited options. They try to turn one way, then the other, but with each move/breath, this boa constrictor monetary system tightens.
So I would not necessarily be surprised if they suddenly announced a tightening this December.
But it doesn't matter. It's just that at this point, I am NOT going to change my behavior based on whether the FED may tighten or not. I am acting assuming that the economy is going to slowly starve, and that any and all investments (with the possible exception of physical PMs?), are at risk, that money you think you have safely saved in the bank, even as it melts away from insidious inflation, is at risk from bail ins, and the goverrnment's need for cash is voracious and so it will be looking at any opportunity to take from the middle class -as we can not protect ourselves from this financial marauder, unlike the elites, nor do we have the voting majority ( if you still believe that elections are not rigged like everything else) like those of the FSA, entitlement minded folks who at this point are only in it for what they can get for themselves, to salvage our former way of life.
+1 - your opinion of a 'what if' that will never ever happen, but...
'what if' the fed *forgave* some portion {say 250 bill} of debt "owed" to it by Uncle Sam.
What affect?
Nothing. They already give back the interest.
can anyone back of the envelope what 25 bps does to us sov debt?
Not much
current outstanding debt (publicly held) = $13.040 trillion
less amount held by Fed ($2.461 trillion) = $10.579 trillion
average interest rate on UST = 2.04%
debt service costs at current rate = $215 billion
debt service costs at +25bps higher rate = $242 billion
So, it adds $27 billion per year in debt service costs.
It'll take a much larger hike to cause serious fiscal problems for USGOV.
...of course, that's ignoring the banks. If they'll get into trouble with a 25bps hike (which is possible, I don't think anyone really knows), and the USGOV is still backing them, well then a small hike could indirectly have major consequences for the USGOV's own finances.
They will not raise rates because they do not want to be blamed for the coming crash.
who care? As always, it is a farce. The fact is that global's economy is dead, no country could bear any tiny higher rate on heavily accumulated debts. Fed is barely a episode show on every other months.
Rising rates will strengthen the dollar on the FX, further collapsing trade and exacerbating the trade deficit.
Rising rates makes homes more expensive to purchase. We just read over the past few days here on ZH the issues the housing market is currently experiencing.
Rising rates will cause a bond market crash, or at a minimum a dislocation of some degree.
Rising rates may cause a trigger to IRS (Interest rate swap) derivatives at .25% but WILL be a trigger at some rate hike point.
Assuming a 20 Trillion deficit, each 1% equates to 200 Billion in additional interest paid each year. CAVEAT: who knows whether this would actually happen given the ability of gov't & FED to jigger reality.
And (DRUMROLL) rising rates has a major impact on the FED's balance sheet as rising rates lower the value of the bonds on it's books. Some have postulated that this could "bankrupt" the FED. I don't know how that actually would work given the power of the FED but just passing along the info.
By thinking the fed can go bankrupt, your comments are all flagged as "made by idiot".
The fed doesn't have to report a profit, it can have an infinite balance sheet, and it never needs to sell. When you print the reserve currency, there is nothing you cannot buy.
A 1/4 point rate increase is like a flea on an elephant. Not noticed.
To make it complete, you need to adoverall taxation of the economy and there you'll see that whenever there's a uptick in tax collection a ratehike is possible.
It can rise because the economy is growing
It can rise because taxes rise
Never the less, there lies one of the most important indicators.
TPTB should set the base rate at a realistic rate, something like 3%, and then let 'nature' take its course. There will be casualties and tears for a short while but all the gunge and falsity will be cleared away.
So the Titanic hit the berg and the capt says Man the pumps and fill the imbalance.
That'll right the ship.
Board staff now see the output gap as closing by Q1 2016. To achieve this closing especially given their mark down of real GDP growth, they sharply lowered their estimate of potential growth in 2015..............
so they lowered the growth estimate. understood.
then they lowered the estimate of potential growth.
and this means they can raise rates?
why dont they just add drugs and prostitution like the euroclowns?
I will believe a rate hike when I see it!
If they do the .025% punk ass hike and the "stawkmarket" takes a shit or a fart, they'll reverse.
Jack Yellen will get his memo from the Douche Brothers Jamie and Lloyd splaining/ordering what to do soon enough.
Just a shitty circus!
You can,
Take all your graphs and your pitches,
consider the paths and the ditches,
weigh the inflation and the glitches,
... but the fed wont raise rates,
until Obama's out of office... bitches.
There they go, model mastrubating again.
I'm sure that everyone realizes that all of the Unemployment, Core and overall Personal Consumption Expenditures, and Gross Domestic Product charts above are lies or are based on lies.
How can unemployment be 4.9% when there are nearly 100 million working age people NOT in the workforce? The real howler is when they say that those people don't want jobs. Well, if that were true, then there should be nearly 100 million vacant job openings in the United States. In reality, September 2015 unemployment was 22.9% per John Williams' ShadowStats.com.
The September 2015 annualized inflation rate is 7.6% per ShadowStats.com.
The US government's measurement of US GDP is probably more honest and more accurate than that reported by the Peoples Republic of China. But, that's faint praise indeed.
One thing no one seems to talk about is the right around the corner of a huge amount of fed balance sheet debt maturance. No indication of whether they will replace that debt. "QT" anyone? anyone?
No hike.
Crash first.
You do realize that if we managed to close the output gap it is EXTREMELY bullish.
That system of equations as written is backward-looking unless part of the selection vectors IG and IH include terminal conditions (e.g., constraints on the slope of the trajectory of expectational variables at the end of planning time).
If the two selection vectors are not forward-looking (i.e., do not include the model's own forecasts of the expectations variables), that implies that the people who built the model think either
? that markets form their expectaitons adaptively (which means that expectations cannot change without an announced change in policy, which is a retarded thing to think, and an even more retarded thing to put into a policy analysis model)...
or ...
? that they don't understand how to code a large equation system to solve numerically in the presents of bi-directional temporal dependence. Solving a model with genuine forward-looking agents is actually really hard to do, because it means that the entire system has to be solved at once, which in turn involves inversion of very large, and relatively sparse, matrices: if expectations are static or adaptive, then the termporal links are only one-way, and the model can be solved iteratively.
The fact that they're doing big Kroneckers looks impressive until you parse it: the whole thing is just getting residuals and weighting them by a set of sensitivities. (If there was MathJax or LaTeX up in this bitch I would write down the formula for the ijth element of PV_COF: it's second year Econometrics, circa 1994).
What this means, is that for all t in T, the representative agent in the model does not operate as if its expectations variables are 'right'... which means that agents are modelled as if they do not behave as if they believe their own expectations at any point in time.
This is a bigger deal than you might think: it represents an assumption that the model's agents (who implicitly rely on the model) know that the model is wrong at all t < T, but use the model's results.In other words, even if you can observe the actual price of bread to be $1, if the model expects it to be $1.50 in the same period the models agents behave as if it's actually $1.50.
That's fucking retarded, and it's what happens when Math majors arb across to economics without anything past first semester Micro.
This takes me back to the mid-90s, when the Australian government's 'default' treatment of expectations was 'quasi-rational in their macroeconometric model (which is called TRYM)'; the equilibrium 'new' level of expectational output was fed into an adaptive expectations mechanism... which meant that the model's outcomes were 'model-consistent' only asymptotically in T.
When - as a grad student - I replicated their model, the first thing I did was incorporate model-consistent expectations for all t in T; the model still solved, but was much more volatile (because expectations variables 'jumped' at the time of policy announcements, not at the time of policy implementations... an even fuller treatment would cause jumps when market participants expected a change in policy in advance of both announcement and implementation).
This imposition of 'rational' expectations was something that they had been unable to do - despite a masssive budget and a team of 15 co-authors for the model.
They also estimated their parameters one equation at a time (which results in biased and inefficient estimators when estimating a system of equations: there are endogenous regressors in almost every estimated equation). When I re-estimated TRYM using N3LS (because FIML is also inefficient in nonlinear systems), the model became so sensitive to any shock, that it was clear that it was mis-specified.
We then got a grant to study how the model would have performed (with QRE and full model-consistent expectations, and with default and N3LS parameters) at forecasting history - this is much harder than you might think. By 'forecasting history' we meant running the model in a forecast closure, which means 'using the data that was used for estimation, then freeing up the endogenous variables, setting the naturally-exogenous variables to their historical levels and forcing the estimation residuals to zero'. (This contrasts to estimation, where the endogenous variables are fixed and the residuals are flexible).
In other words, we did not just compare y (the actual value of the endogenous variables) with 'y-hat' (i.e., y- X'b in a linear system; y - f(X;k) in a non-linear system), because doing that implies that the model's forecast for the 'error/residual' term ? is equal to u (the estimation residual)... which is not true - the appropriate forecast for u is 0 for all T.
So anyhow... doing that had really, really, awful results.
The model's forecasting of history was terrible; the 'equation by equation' estimation protocol was terrible; the treatment of expectations (especially in financial markets) was terrible. But that meant nothing to Treasury's senior bureaucrats ,because by and large they were innumerate.
And if you think that's bad, it's orders of magnitude better than climate models.
Geoffry; I don't know what you do for a profession, but youget my vote for a job at the FED. Flumaxed , I am.
Are the sensitivites trained, as in a neural net?
Talk is cheap
Charts of the future are super-cheap... especially when they come from manipulators like the predators called the federal reserve. They are always wildly wrong.
Output gap closed? Wow they must be smoking some pretty good weed or something. Because as far as I can see, the output gap is gaping wide, and is getting even wider. As large numbers of engineers and scientists are unemployed or underemployed -- the very professions that contribute to adding new capacity. Unless these professionals are fully employed, it really isn't reasonable to conclude that there's some sort of output gap which can't be resolved, in due course, by economic actors picking up the phone and hiring.
The participation rate in the labour force also shows that there is a huge output gap, as there's large numbers of people who would love to return to the workforce but simply aren't allowed to.
Hudson: Let's just bug out and call it even, man! What are we even talking about this for?
Ripley: I say we take off and nuke the entire site from orbit. It's the only way to be sure.
Hudson: Fuckin' A!
Burke: Hold on a second. This installation has a substantial dollar value attached to it.
Ripley: They can *bill* me.
No rate hike until the dollar starts to weaken to 73 or so. Maybe in 2017.
Two observations:
1. Most ZHers believe our banking and economic system is rigged. If you accept that premise, all the equations in the world are a waste of time.
2. The underlying engines that drives economics is demographics and human nature. Until a model can capture human nature, the best any set of equations can do is estimate correlations. How much of your money, or a nation's future, should be wagered on that?
Raising rates means companies cannot borrow more, the is will end or reduce stock buy bcks, may cause companiesto actully pay down dbet, etc etc a whole lot of factors show that raising rates is negative for a debt created bubble. So why would the debt bubble creators give someone else a pin?
Hike and bring down markets. Save the pieces that you want from the money prints. Blatantly do it through Agents (Beware of the shorts squeezes unless you are an insider). Do more to ensure that the charts that you throw out to the mainstream media vindicate your moves to be followed by endless spins. There is an equal chance of no market meltdown but a painted zombie on debt steroids. Take a cue from Japan who is still kicking after lost decades.
I love a tight output gap!!!
Empire of DEBT, wants to raise rates??
Not gonna happens!!
YU-ASS 2015 fiscal outlays, already pays debt interest at 6% GDP!!
http://www.usgovernmentspending.com/federal_budget_detail_fy16bs12015n
That interest based on YU-ASS 0.25% bonds yields.
Wanna bet what the interest outlays of YU-ASS if feds raise the rates 25 bpp??
Bahahahahahahaha....