MNI INTERVIEW: US Demand Still Too Hot For Soft Landing

Total nominal demand in the U.S. continues to grow too fast for achieving a soft landing, and monetary policy will need to remain restrictive for some time yet to kill off inflation, former Dallas Fed principal policy advisor Evan Koenig told MNI.

Nominal demand growth rates should be no more than 4% to see inflation at 2% over the long run, assuming growth potential and trend productivity haven't shifted higher, Koenig said in an interview. While not ruling out rate cuts in the next few months if inflation or inflation expectations see further declines, Koenig said the Fed should communicate that it is doing so to maintain the same level of restrictiveness in policy. (See: MNI INTERVIEW: Fed Could Cut Rates As Early As Q1 - Weinberg)

"We need to remain restrictive for some additional time, until we see signs that interest rate policy is biting. In that case, you might well consider moving to a lower nominal funds rate," he said.

"Policymakers should emphasize it's not mission accomplished yet, and it's appropriate to remain restrictive at this point."

CONSUMER SPENDING

Consumer spending over the past 12 months has risen 5.3%, with its increase over the past six months accelerating to 5.5% -- rates consistent with 3.5% inflation -- while growth in aggregate payrolls is essentially flat at levels compatible with 3% inflation.

Nominal GDP grew at 6.1% over the past two quarters, just a tad lower than the 6.3% rate over the past year and consistent with inflation at 4% over the long term. Dallas Fed trimmed mean PCE inflation is running at 2.9% over the past six months.

"That implies inflation rates of 3%-4% and none of these measures of nominal demand are decelerating significantly. That makes me think it’s too early to think about making policy less restrictive. Policy will have to remain restrictive for some time yet," Koenig said. "I certainly wouldn’t be declaring victory at this point. I'd be resisting any tendency to say we'll be able to start cutting rates any time soon."

NOT SO SOFT

A positive supply shock could reduce inflation in the near term, giving a temporary burst of real growth that's not likely to be sustained. Looking at nominal demand growth allows policymakers to react more appropriately, said Koenig, who spent more than three decades at the Dallas Fed.

"We're not yet seeing nominal demand growth rates that are consistent with a soft landing. The long-run inflation rates embedded in the current rate of nominal demand growth are too high," he said.

Meanwhile, the three-month moving average unemployment rate has risen to 3.8% from 3.5% at the start of the year. Any further increase could portend a harder landing.

"The old rule of thumb is when the unemployment rate rises by a little, it rises by a lot," Koenig said, adding that the critical increase has been 0.3 percentage point using revised data or 0.5 pp in real time. "Anything more than that has been followed by a recession."

"We’re not there yet. But is the unemployment rate finished increasing? If it is, we’re not likely to see further progress on inflation without some further labor market slack. The dynamics of the economy are that once you've overheated the economy, trying to achieve the soft landing is extraordinarily difficult. And it’s not something that we’re on the threshold of achieving at this point."