Thoughts on the potential for a Fed rate hike in 2015 and more

1.

As far as the Fed's decision to implement a 'token' rate hike, my question would be why would they want to tighten in the coming six to twelve months?

A. 

Does the Fed think median household income growth is about to pick up materially to justify such a decision?  Do they think that overall nominal spending/income (nominal GDP) is about to accelerate?  Would the Fed's goal be to slow this process down and if so why? 

It's rightfully often mentioned how labor share of income has been declining for multiple decades.  If the Fed attempts to slow down this recovery and is successful in doing so, it would serve as a great example of how policy decisions are capping labor bargaining power by not allowing unemployment to fall far below what they deem to be a "natural rate of unemployment." 

If you think that monetary policy loses it's effectiveness in boosting nominal economic activity when the policy rate is as close to zero lower bound as it is today for as long as it has been (a reasonable assumption), it doesn't mean that the CB couldn't negatively affect the recovery by increasing the policy rate prematurely.  Again if the Fed were to raise the policy rate and this lead to a slowdown in the fall in the unemployment rate (along with the deceleration/deterioration in other labor force health measures), who are they trying to appease?  Why should workers get the short end after years of sub-par growth and lost output both of which have surpassed  living standards for the majority of households?  I would fight back by saying that there is still too much ground to make up now to push policy in the oppose direction.  

B. 

Then again, does the Fed think that increasing the policy rate could actually cause nominal GDP to accelerate?  If so, what is their theory to support this?  I don't think this is a case they are making therefore I still assume that this move would be to slow down the pace of the recovery.  If so, why does that sound like a good idea for the median household?

2.

I think the present time also serves as a good example of how the Fed can tighten by changing expectations of the future.  Short rates have been rising, the yield curve has been flattening, and importantly the dollar has staged a very fast rally.  Given this, I'm strongly inclined to think that US monetary policy has already tightened from a foreign perspective.  The dollar's rise boosted by the ECB's negative deposit rate instituted in the summer has incentivized capital flows to move toward the US.  Even the oil story isn't one which can be analysed without incorporating the dollar's rise.

 

Here is a possible narrative:  dollar conditions outside of the US have tightened where Saudi Arabia reduced their asking price of oil in response.  The shale excess supply story didn't just appear in the summer.  In the short term, I think the dollar has more to do with the fall in oil prices than shale producers do.

Aside from expectations of monetary policy divergence between the US and the rest of the world, the ongoing deceleration in EM and oil producing economies as commodity prices continue to downtrend after their 2011 cyclical (secular?) peak, suggest that the dollar reserve balances abroad could be in the processes of topping at least temporarily.  Throw in that China continues to attempt to emphasis domestic demand over investment/export lead growth and we could be witnessing a global rebalancing in reserve flows, foreign accumulation, and by extension in the US trade deficit.    

3. 

As far as fiscal policy is considered, it seems that the attitude of "pain" and "austerity" which was felt more intensely two years ago set a path where fiscal policy was going to be limited until possibly the next recession.  It's similar to the early 1980s attitude toward monetary policy.  The Volker Fed at the time targeted the growth in the money supply using the growth in M1 as a main indicator. The Fed set expectations that whenever M1 were to exceed their desired pace, they would restrict the use of their balance sheet (open market operations) in attempts to slow the pace of money growth down.  In anticipation of this, market participants adjusted asset prices to reflect the Fed's intentions.  In doing so, they kept the price of money, interest rates on treasuries especially, too high causing the economy to contract.  All this was to combat the inflation monster of the 1970s (which I really think is a story having to do with spiking oil prices and credit deregulation and not policy being too easy).   

The Fed eventually was forced to abandon this approach to monetary policy.  Events had proven their theory wrong!  The economic contraction, at least during the time when inflation had fallen rapidly while rates remained high, was a result of a policy mistake. 

The corollary to today is that fiscal policy restriction is judged to be a necessary pain which the economy needs.  "We need to tighten our belts" or "the government needs to get out of the way"  and the idea that increased deficit spending will lead to doom have all been mantras promoted which have been used to justify the non-use of fiscal policy as a way of boosting the recovery.  In light of this, I do currently see the frustratingly slow uneven recovery as a result of a flawed policy ideology, but this time on the fiscal side.

 

The Fed was forced to change the way they conducted monetary policy in the 1980s.  If the slow growth we are seeing now starts to decelerate, maybe Congress and the President will be forced to reconsider their approach to fiscal policy.   

My fear is that expectations of what constitutes a strong recovery and expansion have both been dumb down to the point where policymakers are passively accepting today's conditions.  I really hope we collectively don't lose sight that the US and the global community can do much better than this in raising the living standards for the most people possible.  It doesn't need to be this way.  I am not a doom and gloomer because with the right policy changes a more rapid, environmentally friendly, domestic and global economic expansion that improves our lives is possible. 

Policymakers on the fiscal side need to wake up to the fact that they are not the ones suffering from their policy ideology.  The family or person suffering from year's of lost income, unemloyment, underemployment, and the economy as a whole which loses this potential are the ones taking the "pain."  Perhaps one day a political figure will arise that cares about legacy and the greatness of the nation more than their personal wealth and bottom line.

Belief is powerful as it has the ability to transform and enable a person and nation to endure during a period of difficulty and stagnancy.  My hope is that we haven't lost our belief that real change is actually possible during periods of relative calm.  Then again, despite his support for the flawed monetarist ideals of the 1980s, perhaps Milton Friedman had it right when he wrote the following:

"There is enormous inertia—a tyranny of the status quo—in private and especially governmental arrangements. Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable."