Mickey Levy is certain about at least one thing after the hotter-than-expected September jobs report that left many economists and investors scratching their heads over just how aggressive the Federal Reserve can be, even needs to be. As more signs accumulate that, far from heading the economy toward recession the labor market may be picking up steam again, the Fed will need to recalibrate its monetary policy path and not in they way that Chair Jay Powell put on the table recently.
Let me share an excerpt from a report this decades-long Fed watcher, Wall Street economist, and more wrote after report was released on Friday. His thesis?
”A recalculation is now in order--by the Fed and by financial markets.
”The current effective Fed funds rate of 5.1% is 2.5 percentage points above inflation. The Fed characterizes monetary policy as restrictive, primarily because the real FFR is higher than the low real policy rate that persisted in the decade following the Financial Crisis, and is also far above its internally generated estimates of r*, the natural rate of interest that is consistent with 2% inflation and the economy growing along its potential path.
”But how restrictive is monetary policy if the real economy continues to grow faster than the Fed's estimate of potential and inflation remains above the Fed's 2% target? The Fed was so anxious to cut rates aggressively and do a victory lap, hoping that people would applaud the rate cuts and forget its inflationary blunders of 2020-2022 that are still affecting economic activity.
“The Fed needs to take a close look at its 1.8% estimate of potential growth, which it has not changed despite the pickup in labor productivity and the increase of 9 million immigrants since 2020 that assuredly is lifting the labor force and employment.
”In the second half of the 1990s, which enjoyed strong gains in productivity and economic growth, the real federal funds rate was higher than it is currently. If r* is closer to the 2% that the Taylor Rule established in 1993, the Fed still has room to lower rates, but it should do so judiciously and less aggressively than it had led markets to believe.”
In our extensive interview Mickey looked at what’s driving this. The impact of rising productivity and a burgeoning migrant-led labor force, and the need for this to be reflected in its estimate of the natural real rate of interest, or R*. Why and how a higher neutral rate will limit the number of rate cuts the Fed can do now, and why 4% is the more likely bottom in the Fed’s key rate, rather than the 3% rate many economists and investors are forecasting. And a whole lot more. Have a look and a listen.
Mickey Levy is a macroeconomist who uniquely analyzes economic and financial market performance and how they are affected by monetary and fiscal policies. Dr. Levy started his career conducting research at the Congressional Budget Office and American Enterprise Institute, and for many years was Chief Economist at Bank of America, followed by Berenberg Capital Markets. He is a long-standing member of the Shadow Open Market Committee and is also a Visiting Scholar at the Hoover Institution at Stanford University.
Dr. Levy is a leading expert on the Federal Reserve’s monetary policy, with a deep understanding of fiscal policy and how they interact. He has researched and spoken extensively on financial market behavior, and has a strong track record in forecasting. Dr. Levy’s early research was on the Fed’s debt monetization and different aspects of the government’s public finances. He has written hundreds of articles and papers for leading economic journals on U.S. and global economic conditions, and has been an active voice on how financial markets are influenced by monetary policy. He has testified frequently before the U.S. Congress on monetary and fiscal policies, banking and credit conditions, regulations, and global trade, and is a frequent contributor to the Wall Street Journal, Bloomberg, and other media.
He is a member of the Council on Foreign Relations and the Economic Club of New York, and has previously served on the Panel of Economic Advisors to the Federal Reserve of New York, as well as the Advisory Panel of the Office of Financial Research.
Fed Needs to Recalculate Neutral Rate in Wake of Strong Jobs Report: Levy