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Richard Bernstein: You are what your real fed funds rate says you are

Section: Daily Dispatches

By Richard Bernstein
Financial Times, London
Tuesday, May 10, 2022

Former NFL coach Bill Parcells famously said, "You are what your record says you are." A team's coach might try to rationalise a losing record by highlighting good planning, unfortunate injuries, or players' small miscues but the stark reality is a team with a losing record is a poor one.

The Federal Reserve claims to be fighting inflation, but before one proclaims the central bank "hawkish," it seems appropriate to paraphrase Parcells: You are what your real fed funds rate says you are.

... Dispatch continues below ...


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The real fed funds rate (the difference between the target rate for the central bank and inflation) has historically been a reliable gauge of the monetary policy. When the real fed funds rate is positive, interest rates are high enough to slow nominal growth. But when the real fed funds rate is negative, it suggests the Fed is trying to stoke the economy.

Every U.S. recession in the past 50 years has been preceded by a positive real fed funds rate. And the Fed correctly kept the real funds rate negative during most of the period after the financial crisis because the falloff in bank lending made deflation a bigger risk than inflation.

Despite the fact that inflation is at a 40-year high by virtually any measure, the real fed funds rate is now negative to a degree that is far beyond historic averages. Measured using the consumer price index, the real fed funds rate is negative 7.5% versus the 50-year average of 1%. The real funds rate was more than 10% at the peak of the 1980s inflation-fighting Volcker regime.

The U.S. and global economies have meaningfully changed in 40 years and Volcker's extraordinary monetary tightening may not be warranted today. But one should seriously question whether the current real fed funds rate will slow the economy let alone curtail inflation. ...

The Fed wants to be viewed as a conscientious inflation fighter, but the extremely negative real fed funds rate says otherwise. Despite the Fed's jawboning, they are what their real fed funds rate says they are.

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