Interest Rates: The Case for Tightening is Getting Weaker and Weaker

The recent plunge in TIPS spreads is reaching frightening proportions:

5 year  =  1.09%
10 year  =  1.42%
30 year  = 1.61%

Yes, I know they can be distorted by illiquidity, but they are not THAT far off market expectations. And don’t forget they predict CPI inflation, which runs about 0.3% above the Fed’s preferred PCE.  In essence, the Fed has a 2.3% inflation target.  They aren’t likely to hit it.

Also recall that since 2007 the Fed’s been consistently overly optimistic about future growth in AD—the markets have been more pessimistic, and more accurate.

Also recall that Fed policy has a big impact on the global economy.

Also recall that the global economy seems to be moving into a disinflationary cycle.

Given that Fed tightening has the potential (and I emphasize the potential, maybe a 1 in 6 chance) of driving the global economy into a recession, and given there is basically no upside from tightening now, the Fed’s got to ask itself one question:  “Do I feel lucky today?

And if China is far worse than I assume, then . . . well, look out below.

About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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